Mexico Quarterly Inflation Report: Not ready to hike amid softer growth

Banxico published its Quarterly Inflation Report for the second quarter. The highlight of the report is the reduction - once again - of its annual growth forecast for 2015 to a range of 1.7-2.5% from 2.0-3.0% previously, due to weaker than expected performance during H1, particularly explained by lower oil production and slower dynamism in manufacturing exports. The inflation outlook was unchanged as the board believes that annual inflation should close below 3% in 2015 and stay close to target during 2016.

The economy continues to reflect an important level of slack and inflation expectations remained anchored. Banxico believes that one factor that has helped maintain inflation under control is the fact that the output gap remains negative and it expects that it will only close gradually, given the slower than expected growth. However, the main risk to inflation is the still unobserved FX pass-through to non-tradable prices, hence the concerns of the board about this factor.

The real depreciation of the MXN has occurred in an orderly manner. Banxico believes that the performance of the peso is in line with weaker global growth, the expectation of higher rates in the US and lower oil prices. In particular, Governor Carstens mentioned in the press conference that the recent FX intervention measures implemented by the FX commission have been adequate to curb this volatility.

Only an additional strong depreciation of the USDMXN might trigger a hike before the US Fed. The recent FX intervention suggests that Banxico will likely first use these type of mechanisms to curb excessive volatility in the FX market rather than hike rates. However, if additional pressures on the MXN are observed in the very short term, for example, the USDMXN reaching levels close to 16.90 or beyond in the following weeks, it is believed that Banxico will likely consider hiking rates independently of a US Fed action. Although this event most likely would occur under the assumption of a highly probable hike by the Fed, additional events in the global financial markets could trigger this volatility (i.e., the recent yuan devaluation).

"So far, we maintain our call for a September hike. Although this call is at risk since the probability of a September hike by the Fed has declined, inflation in Mexico remains stalled and the fact that Banxico has acknowledged weaker dynamism of the economy motivating a change in its GDP growth forecast. In that sense, the minutes of the latest July meeting due tomorrow and the performance of the MXN will give us more information," says Barclays.