Mexico - Economic Briefing November 2004

Rising Inflation Triggers Additional Monetary Tightening  (continued)

Outlook remains robust owing to favourable global backdrop
Owing to the current mostly positive picture suggested by the latest data releases, Consensus Forecast panellists remain optimistic about growth prospects for the remainder of the year and 2005.  In addition to the favourable global setting, the buoyant outlook for the U.S. economy should provide a solid backdrop for continued recovery in Mexico.  Panellists believe the economy will grow by 4.4% in September, resulting in a third quarter expansion of 4.2%.  However, the Finance Ministry announced on 4 November that the economy expanded by 4.0% in the third quarter, which, if confirmed, would correspond to 3.6% to 3.8% growth in September.  According to the Consensus, the economy will maintain the current expansion pace, growing by 4.2% in the final quarter.  For the full year, Consensus Forecast panellists expect the economy to grow by 4.0%, which is unchanged from last month’s forecast and follows on upward revisions in the previous three months.  The prospects for further acceleration in economic growth, however, remain less favourable, as suggested by the 3.6% growth rate anticipated for next year.  The increased competition from China in Mexico’s prime export markets and the inability of the Fox administration to implement much-needed economic reforms in the run-up to the presidential elections in July 2006 are key obstacles to the establishment of a more resilient economic growth trend. 

Headline inflation continues to rise in early October
In the first half of October, consumer prices increased 0.51%.  The actual rate was well above the 0.18% registered in the prior two-week period and also significantly exceeded market expectations, which had prices growing by 0.30% in the first half of October.  Higher prices for fresh fruits and vegetables accounted for almost half of the entire price spike and thus constituted the main driver behind the October increase.  The price spike pushed annual headline inflation from 5.1% in September to 5.4%, the highest rate registered since March 2003.  The majority of the October price increase was concentrated in the price categories that experience more erratic shifts and are not included in the core inflation index.  Thus, the core inflation index increased by only 0.19% in the first two weeks of October and annual core inflation remained unchanged at 3.8%.  Thus, even though headline inflation continues to drift away from the upper limit of the Central Bank’s one percentage point tolerance around a 3.0% central target rate, the core inflation rate is still within the established limits.  Central Bank president Guillermo Ortiz claimed in early November that the Bank does not expect core inflation to exceed the 4% threshold and sees core inflation dropping as early as the first quarter of 2005.  

Central Bank tightens monetary policy to stem inflation rise
Nevertheless, on 22 October, the Central Bank decided to raise its money market "short" (corto) to 57 million pesos per day from 51 million pesos.  An increase in the corto reduces overnight lending to banks and indirectly drives up interest rates.  This was the seventh time this year that monetary authorities have acted to stem rising inflationary expectations.  With inflation persistently above target rates, markets had widely expected a tightening of monetary policy.  As a result of the tightening, the 28-day benchmark Cetes rate rose to 7.97% on 28 October, which is up from 5.5% at the beginning of the year.  Consensus Forecast panellists have hiked their year-end interest rate forecast by 0.4 percentage points over last month to 7.8% and believe that the potential for an easing of monetary policy is limited, as the 2005 year-end interest rate is projected at 8.3%.  Despite sustained monetary tightening, Consensus Forecast panellists continue to raise their forecasts for inflation.  Panellists see year-end inflation at 4.7%, up 0.4 percentage points compared to last month’s forecast.  The forecast for next year also increased a notch to 4.0%, just at the reiterated upper limit of the 1% tolerance margin of the 3% central target rate.