Mexico Quarterly Inflation Report: Persistent downside risks to growth with stable and low inflation

Banxico released its Quarterly Inflation Report for Q3 15. The highlight of the report is the release of the 2017 forecasts in which the board has a positive outlook for both growth and inflation, while it confirms the views in terms of monetary policy: there is no need to hike until the economy is back to its potential, as long inflation expectations remain stable. In that sense, linking the decision to the Fed seems less likely.

GDP growth for 2017 is expected to be between 3.0-4.0% and the output gap will remain negative in the coming quarters. The report adjusted the 2015 GDP forecast interval to 1.9-2.4% from 1.7-2.5% previously, while it maintains the 2016 forecast unchanged at 2.5-3.5%. Under these estimates, the output gap will likely be closed by the end of 2017. It is worth highlighting that the central bank acknowledged a lower dynamism of the auto industry, "given the recent developments for some market participants of this sector," as a new downside risk to growth.

Inflation outlook is still very benign and it should improve in 2017. The board confirmed that inflation will remain very close to 3% during 2016, with base effects pushing inflation up, but this is not considered a generalized deterioration in the dynamics of inflation. In 2017 inflation should observe a slight downward trend to later close at 3.0% by year-end. It is worth highlighting that Banxico estimates that the accumulated FX pass-through in Mexico in the past 12 months has only been 3.8 basis points, a number much lower than in other economies (Brazil: 26.8, Chile: 17.5, Peru: 9.4 and Colombia: 4.6bp).

Major risk to inflation continues to be excessive financial volatility but only if it affects inflation expectations. If market volatility persists, the MXN could depreciate further and it could affect inflation expectations, triggering a policy reaction. Previous episodes of volatility suggests that this will likely not be the case, combined with the fact that gasoline prices will be capped at 3% in 2016 and some prices might observe declines, derived from the structural reforms.

"We identify a very dovish tone and we confirm our view that the bias is to remain on hold as long as possible", says Barclays.

The outlook for growth and inflation suggests that there is no need to hike rates on the back of stable inflation expectations. Also, it is believed that once the Fed hikes, the MXN will depreciate but rates will likely remain relatively stable. This will allow Banxico to wait for better domestic numbers to make a move. The first hike is expected in June 2016, which implies a policy reaction less likely to be linked to a US Fed movement.