Mexico - Economic Briefing February 2006

Central Bank Continues Easing Amid Sluggish Economy

The economy continues to ail along. In spite of high oil prices, which provide the public sector with additional spending power, the Mexican economy fails to fire up. In particular, the industrial sector is disappointing, as it has to cope with an ever increasing pressure increasing competition from Asian manufacturing hubs. Meanwhile, monetary authorities to continue cutting interest rates, as core inflation is in line with the Central Bank’s inflation target.

Economy continues slowdown

In November, economic activity increased 2.7% over the same month last year, according to the global indicator for economic activity (IGAE, Indicador Global de la Actividad Económica).  The actual reading fell short of last month’s Consensus Forecast expectations, which had the economy growing 3.9%.  In October the economy expanded by 3.0% year-on-year.  The slowdown over October was due to slower growth in services and an even stronger contraction in agriculture.  Industry, on the other, accelerated over October.  A month-on-month comparison confirms the sluggish pace suggested by the annual data.  According to seasonally adjusted data, the economy was virtually unchanged over the preceding month.  The slump in November confirmed the downward trend that has been in place since the beginning of last year.  In November, the annual average growth rate dropped 0.3 percentage points from 3.3% in October to 3.0%, the tenth consecutive month without an increase. 

Economic growth to remain moderate but stable in spite of presidential elections

Unemployment continued to decline from 3.0% in November to 2.8% in December.  While erratic shifts in unemployment figures render the indicator a somewhat unreliable gauge of current economic developments, the December reading marks the fourth consecutive month of declining unemployment, which indicates a sustainable improvement in employment.  Moreover, consumer confidence continued to increase.  In January, the consumer confidence index reached 108.7 points, which was 0.6 percentage points above the December reading.  While the increase was relatively small, the strength in consumer confidence shown by the strong 5.4 percentage point increase registered in the previous month was sustained.  Since September last year, consumer confidence increased in four of the five months, with only November registering a small decline.  Declining confidence in the country’s current economic state compared with a year ago precluded a more pronounced increase.  However, households’ plans to purchase durable consumer goods increased strongly for the second consecutive month, which bodes well for private consumption in the first quarter of this year.  Consensus Forecast panellists are nevertheless cautious about the prospects for the first quarter and the full year.  The panel expects gross domestic product (GDP) to expand 3.3% over the first quarter 2005, which would represent only a slight acceleration over the fourth quarter if the preliminary government estimate of 3.0% growth is confirmed.  Official national accounts data for the fourth quarter will be released on 15 February.  The Consensus sees economic growth accelerating steadily throughout the year to reach 3.6% in the final quarter 2006.  For the full year, the economy will expand 3.5%, which is at the upper end of the Central Bank’s 3.0% to 3.5% projection.  Apparently, neither the Central Bank nor the private sector expects the upcoming July presidential elections to dent economic growth.  During the past decades, Mexico was notorious for stumbling into economic crisis in the wake of presidential elections. However, Vicente Fox’s presidency has effectively broken the spell and Consensus Forecast panellists expect the economy to grow an unspectacular but solid 3.2% in 2007.

Inflation spikes in January

In January, consumer prices increased 0.59%, just above the 0.55% projection in last month’s Consensus Forecast.  In December, consumer prices had increased 0.61%.  Food, beverages and tobacco experienced the strongest price rise in January, exacerbated by higher housing and transport prices.  Since prices were flat in January last year, annual headline inflation jumped from 3.3% in December to 3.9% in January, the highest rate since August last year, which put an abrupt end to the trend to more subdued inflation observed in the second half of last year.  In November 2005, annual headline inflation had reached 2.9%, the lowest level since the Central Bank started reporting inflation in 1969.  The core inflation index, which excludes more volatile categories such as oil and fresh fruits and vegetables, increased by 0.24% and annual core inflation dropped a notch from 3.1% in December to 3.0% in January.  Thus, headline inflation is now again well above the Central Bank’s 3.0% central target rate.  Consensus Forecast panellists expect consumer prices to increase 0.34% in February, which would keep headline inflation at the current 3.9%.  For this year, however, Consensus Forecast panellists expect inflation to decline, ending 2006 at 3.6%, which is 0.1 percentage points lower than last month’s forecast.  The Central Bank expects overall inflation between 3.0% and 3.5% in 2006, with core inflation steady at around 3.0%.

Central Bank cuts interest rate for sixth consecutive month

Weaker domestic demand and the benign inflationary environment have prompted Banco de México to continue to loosen monetary policy.  On 27 January, the Central Bank reduced the benchmark lending rate for the sixth consecutive month.  In a statement, the Central Bank said that monetary conditions would be allowed to ease no more than 50 basis points.  The move effectively reduced the overnight lending rate to 7.75% from 8.25%, the second time the Central Bank reduced the rate by as much as half a percentage point since implementing a target interest rate in August 2005.  The traditional policy tool, the so-called corto or “short”, which indirectly influences interest rates by lowering or increasing the amount the Central Bank lends overnight to the banking system, was left unchanged at 79 million pesos.  The Central Bank maintains the corto as a policy tool but has not made any adjustments since switching to direct interest rate targeting.  The market had anticipated the Central Bank to cut interest rates and the benchmark 28-day Cetes rate dropped from 8.02% on 29 December to 7.73 on 26 January, the lowest rate since October 2004.  Consensus Forecast panellists expect the benchmark interest rate to drop throughout the year, ending at 7.3%, which is down 0.6 percentage points over last month’s forecast.

Exchange rate appreciates in spite of interest rate cuts

In January, the Mexican peso reversed the depreciation observed in December and appreciated by 1.7% in nominal terms from 10.63 pesos to the US$ at the end of December to 10.45 pesos to the US$ at the end of January.  Compared to the same month last year, the Mexican peso has gained 6.9% in value versus the US$, which makes it one of the strongest major currencies in the world.  The peso strengthened in spite of recent Central Bank interest rate cuts, which render investments in Mexico less attractive.  However, Consensus Forecast panellists expect further interest rates cuts this year to prompt the peso to depreciate again and see the currency at 11.29 pesos versus the US$ by the end of the year, 5.9% weaker than at the end of 2005.