monetary policy outlook for mexico

Monetary Policy Outlook for Mexico

J.P. Morgan Investor SeminarWashington, DC, 8 October 2016

Mr. Javier Guzmán Calafell, Deputy Governor, Banco de México

Outline

2Monetary Policy Outlook for Mexico

Macroeconomic Policy Response4

Evolution of the Mexican Economy2

Final Remarks5

Monetary Policy in Mexico1

Inflation and its Determinants3

3

Monetary policy in Mexico is implemented at present in a complex environment:

A negative output gap, with forecasts suggesting that it will remain in negativeterritory through end-2017.

A rate of inflation that has remained under the 3 percent target for 17 months.

On the other hand, an important depreciation of the peso, with potential inflationaryconsequences.


4

This was reflected in the dispersion of analysts’ expectations on the reference rate priorto the last monetary policy decision.


Mexico: Analysts’ Expectations for Next Monetary Policy Rate Adjustment1/

Basis points

1/ As of 26 September 2016.Source: Banco de México, Banamex, Reuters and analysts’ reports.

September November December2016 Monetary Policy Meetings

0

25

50

75

Outline




Final Remarks5



6

The pace of economic activity moderated significantly during the second quarter of 2016,affected in part by factors of a transitory nature.

s.a./ Seasonally adjusted.Source: INEGI.


Mexico: Gross Domestic ProductAnnual %, s.a.

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2014 2015 2016

2Q

7

The most recent information points to an upturn of economic activity in the third quarter,although with signs of deceleration. Services have continued to provide the main stimuluson the supply side, but trend growth in this sector seems to be slowing.


Mexico: IGAE 1/

Index 2008 = 100, s.a.

1/ Monthly GDP proxy.s.a./ Seasonally adjusted.Source: INEGI.

90

95

100

105

110

115

120

125

2008 2009 2010 2011 2012 2013 2014 2015 2016

Total Industry Services

July

Monetary Policy Outlook for Mexico 8

Private ConsumptionIndex 2008 = 100, s. a.

Gross Fixed InvestmentIndex 2008 = 100, s. a.

s. a./ Seasonally adjusted.Source: INEGI and ANTAD.

s. a./ Seasonally adjusted.Source: INEGI.

On the demand side, economic activity has been supported mainly by private consumption,which also shows indications of losing speed. Investment has remained weak.

70

80

90

100

110

120

130

140

150

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

Total

Construction

Machinery and Equipment

July80

90

100

110

120

130

140

150

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

Private Consumption in the Domestic Market

Total ANTAD Sales

JulyAugust

Monetary Policy Outlook for Mexico 9

Mexican Non-Oil Exports and US Industrial ProductionIndex 2008 = 100, s. a.

s. a./ Seasonally adjusted.Source: SAT, Secretaría de Economía, Banco de México, INEGI, Blue Chip and Federal Reserve.

The downward trend in manufacturing exports seems to have stopped, but they remainsluggish. The expected recovery of industrial output in the United States would stimulateexternal sales.

ExportsIndex 2008 = 100 1/

1/ Trend data.Source: SAT, Secretaría de Economía, Banco de México and INEGI.

70

85

100

115

130

145

160

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

Total

Non-Oil

Manufactures

August100

101

102

103

104

105

106

107

135

140

145

150

155

160

165

170

20

14

20

15

20

16

20

17

<- Mexican Non-Oil Exports

US Industrial Production ->

August

Forecast

10

Labor market indicators send mixed signals, but in general they are consistent with a gradualdeceleration of economic activity.

Mexico


Unemployment Rate and Employed Population% (s.a.) and million workers

Source: INEGI.

Nominal Wages 1/

Annual % change

1/ Daily average for all IMSS-affiliated workers.Source: IMSS.

0

1

2

3

4

5

6

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

2Q

35

38

41

44

47

50

53

56

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

2011 2012 2013 2014 2015 2016

<- Unemployment Rate Employed Population ->

2QAugust

-7

-6

-5

-4

-3

-2

-1

0

1

2

3

4

5

6

7

-7

-6

-5

-4

-3

-2

-1

0

1

2

3

4

5

6

7

Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4

11

In this context, the output gap is projected to remain negative through end-2017.


Output Gap Estimates and Projections% of potential, s.a.

s.a./ Seasonally adjusted.Source: Banco de México.

2015Q4

2016 Q4

2017Q4

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

12

GDP growth in Mexico has been restrained by the evolution of economic activity in the US.Yet, Mexico’s economy has shown resilience to this shock...

s.a./ Seasonally adjusted.Source: Bureau of Economic Analysis and Federal Reserve.


US: GDP, Industrial and Manufacturing ProductionAnnual %, s.a.

Mexican GDP vs. US GDP, IP and Manufacturing ProductionIndex 2013-Q4 = 100, s.a.

s.a./ Seasonally adjusted.Source: INEGI, Bureau of Economic Analysis and Federal Reserve.

-2

-1

0

1

2

3

4

Jan

-14

Ap

r-1

4

Jul-

14

Oct

-14

Jan

-15

Ap

r-1

5

Jul-

15

Oct

-15

Jan

-16

Ap

r-1

6

Gross Domestic Product

Industrial Production

Manufacturing Production 2Q99

100

101

102

103

104

105

106

Oct

-13

Jan

-14

Ap

r-1

4

Jul-

14

Oct

-14

Jan

-15

Ap

r-1

5

Jul-

15

Oct

-15

Jan

-16

Ap

r-1

6

MX GDP

US GDP

US IP

US Manuf.

2Q

13

…with structural reform efforts as an important explanatory factor.

Source: World Economic Forum.


Emerging Market Economies: Change in GlobalCompetitiveness Index Score between 2015 and 2016

Points

Mexico: Global Competitiveness IndexScore (1-7 scale) and Ranking

Source: World Economic Forum.

-0.10

-0.05

0.00

0.05

0.10

0.15

0.20

0.25

Mal

aysi

a

Hu

nga

ry

Bra

zil

Ind

on

esia

Thai

lan

d

Co

lom

bia

Turk

ey

Per

u

Ko

rea

Sin

gap

ore

Ch

ile

Ch

ina

Po

lan

d

Ru

ssia

S. A

fric

a

Mex

ico

Ind

ia 4.0

4.1

4.2

4.3

4.4

4.5

Average 2006-2015 2016

<- Score

50

52

54

56

58

60

Average 2006-2015 2016

Ranking ->

Outline




Final Remarks5



15

Headline CPI Inflation%

Source: Banco de México and INEGI.


Inflation has displayed a favorable behavior, and currently stands at 2.97 percent, slightlybelow the 3 percent target.

0

1

2

3

4

5

6

2010 2011 2012 2013 2014 2015 2016

September

Variability Interval

16

CPI Inflation: Core vs. Non-Core%


The core and more recently the non-core components show an upward trend, but theyremain at moderate levels.


0

1

2

3

4

5

6

7

8

9

10

11

2010 2011 2012 2013 2014 2015 2016

Core Non-Core


September

17

Core CPI Inflation: Merchandise and Services%


So far, the pass-through from the exchange rate depreciation has been concentrated onthe prices of merchandise, which have increased relative to those of services.


0

1

2

3

4

5

6

7

2010 2011 2012 2013 2014 2015 2016

Merchandise Services


September

18

Inflation is projected to gradually increase towards year-end to slightly above 3 percent,and to fluctuate around this level in 2017. Survey-based long-term inflation expectationsremain anchored, although still somewhat above the target.

Inflation Expectations 1/

Annual %

1/ Median expectation.Source: Banco de México and Banamex.


2.8

3.0

3.2

3.4

3.6

3.8

2010 2011 2012 2013 2014 2015 2016

Next 2-6 Years (Banamex) Next 5-8 Years (Banco de México)

Permanent TargetSeptember

October

19

CPI Inflation: Agriculture and Livestock%


Demand pressures on prices are likely to remain subdued, given the expectation of anegative output gap throughout next year. The evolution of prices of agriculture andlivestock represents an upward risk, although of a transitory nature.


-3

0

3

6

9

12

15

18

2010 2011 2012 2013 2014 2015 2016

Average 2000-2015: 5.8%

September

20

USD/MXN: Level and Volatility 1/

Pesos per dollar and %

1/ Implicit volatility in 1-month USD/MXN options.Note: Vertical lines indicate dates when the reference rate in Mexico was increased in 2015 (17 December) and 2016 (17 February, 30 June and 29 September).Source: Banco de México and Bloomberg.


Therefore, the main risk for the inflation outlook arises from the evolution of the exchangerate of the peso.

4

6

8

10

12

14

16

18

20

12

13

14

15

16

17

18

19

20

Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16

<- Level Volatility ->

October

21

The steep depreciation of the Mexican peso over the last couple of years is explained by a combination of factors, including:

Normalization of monetary policy in the United States.

Uncertainty regarding the outcome of the US electoral process.

An environment of generalized anxiety among international investors.

The use of the peso as a hedging instrument against risks in other emerging markets andfor speculative purposes.

Weak oil prices.

Deterioration of public sector finances.

A higher current account deficit.


Outline




Final Remarks5



Notwithstanding a negative output gap, low inflation and well anchored inflationexpectations, monetary policy has been tightened four times since late 2015.


December 17, 2015 25bps increase to 3.25%.

A response to an increase in the target range for the federal funds rate in the US, inview of:

Close links between the Mexican and US economies;

An environment of widespread nervousness in international financial markets;

A very open capital account in Mexico; and

High peso-dollar exchange rate levels;

A narrowing of the interest rate differential between the US and Mexico could haveresulted in disorderly capital outflows, and risks for inflation and financial stability.


February 17, 2016Extraordinary Meeting

50bps increase to 3.75%.

June 30, 2016 50bps increase to 4.25%

September 29, 2016 50bps increase to 4.75%

Main explanatory factors:

Expectation of an upward trend for inflation even in the absence of further shocks;

Risks for inflation and its expectations from the depreciation of the exchange rate;

Possibility of a higher than anticipated peso-dollar rate for a significant period;

Potential non-linear effects of the exchange rate on prices; and

Risk of adverse signaling in the absence of decisive action.

Banco de México’s mandate.

2.75

3.25

3.75

4.25

4.75

5.25

5.75

6.25

6.75

7.25

1 1 3 6 1 2 3 5 10 20 30

15-Dec-15 16-Feb-16 29-Jun-16

28-Sep-16 6-Oct-16


Yield Curve%

Source: Banco de México and Proveedor Integral de Precios (PiP).

Months YearsDay

The impact of a higher monetary policy rate on economic activity has been alleviated by aflattening of the yield curve.

26

The Banco de México has noted that the latest increase in the monetary policy ratedoes not intend to begin a cycle of adjustments.

Considering the nature of some of the factors affecting the peso at present, andespecially the electoral process in the United States, it is difficult to evaluate thepossible trend of the monetary policy rate in Mexico in the very short term.

Beyond this special period, interest rates in Mexico are likely to be significantly affectedby the evolution of interest rates in the United States.


27

1/ Based on market prices of futures for the Federal Funds Rate.Source: Banco de México with data from Bloomberg.


Markets continue to anticipate a gradualtightening of monetary policy in the US.

The net effect should be beneficial forMexico’s economy.

If adequately anticipated, it need nothave a major impact on internationalfinancial markets.

However, under circumstances similar tothose prevailing at present, the absenceof a monetary policy response in Mexicowould give rise to major risks.

US: Probability of a 25bp Increase in the Targetfor the Federal Funds Rate1/

%

0%

25%

50%

75%

100%

125%

150%

175%

Sep

tem

ber

No

vem

ber

Dec

emb

er

Feb

ruar

y

Mar

ch

May

Jun

e

July

Sep

tem

ber

No

vem

ber

Dec

emb

er

2016 2017

Latest FOMC meeting: 21/09/2016

Current: 07/10/2016

28

Banco de México’s Board will closely monitor the evolution of all determinants ofinflation and its medium- to long-term expectations, and especially:

The exchange rate given its possible pass-through to consumer prices, withoutimplying an objective for the exchange rate.

The relative monetary policy stance between Mexico and the US.

The evolution of the output gap.

The Banco de México will adjust the monetary policy stance with all due flexibility,at the moment and in the magnitude that conditions require it, to consolidate theefficient convergence of inflation to the 3 percent target.


29

Source: SHCP.

Strong public finances are essential to preserve macroeconomic stability and strengthenconfidence. The implementation of the announced program of fiscal adjustment in 2017would alleviate risks from this source…

Public Sector Finances, 2015-2017% of GDP


-6

-5

-4

-3

-2

-1

0

1

Primary Balance PSBR

2015 2016 2017

-60

-50

-40

-30

-20

-10

0

10

Historical Balance of PSBR

30

Note: Data for 2016 corresponds to the first half.Source: Banco de México and INEGI.

… and from the current account which, although still within reasonable margins, hasgiven rise to some nervousness.

Mexico: Current Account Deficit and Net FDI Inflows% of GDP


-1

0

1

2

3

4

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

Current Account Deficit

Net FDI Inflows

Emerging Market Economies: Current Account% of GDP

Source: IMF (World Economic Outlook, October 2016).

-8

-6

-4

-2

0

2

4

6

8

Co

lom

bia

Turk

ey

Per

u

Bra

zil

Mex

ico

Ind

on

esia

Ch

ile

Ind

ia

Po

lan

d

Mal

aysi

a

Hu

nga

ry

Ko

rea

2015 2016

31

Intervention in the foreign exchange market can also play a role in coping withexchange rate volatility.

The Foreign Exchange Commission has emphasized that anchoring of the Mexican pesowill be sought through the preservation of strong economic fundamentals.

However, it has also been noted that discretionary intervention in the foreign exchangemarket cannot be discarded should exceptional circumstances arise.


Outline




Final Remarks5



33

Mexico’s economy has performed relatively well in a rather difficult environment, but theneed to strengthen economic fundamentals has increased.

This implies:

Adherence to a monetary policy approach emphasizing prudence.

An adjustment of public finances leading to a sustained decline in the share of publicdebt in GDP.

The implementation of any policies required to ensure the preservation of financialstability.

Continued reinforcement of the domestic sources of growth.


monetary policy outlook for mexico

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