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Headline and core inflation in January continued to show the pace of disinflation in Mexico slowing at the beginning of the year, confirming that it was not a trend isolated to Q4 2023. Headline inflation rose by 0.89% month-on-month, up from 0.71% in December and reaching the highest pace since March 2022.
The year-on-year rate in January stood at 4.88%, 0.22 percentage points above December’s reading, in line with expectations, registering the third consecutive increase since reaching a 38-month low of 4.26% in September. Core inflation rose by 0.40%, above the economist consensus of 0.39%, but slightly below the 0.44% recorded in December. On a year-on-year basis, core inflation slowed again to 4.76% from 5.09% in the previous month, a fall of 3.69 percentage points since January last year. However, we believe that this is largely explained by positive base effects. This, together with the unfavourable core services data, demonstrates that inflation levels remain uncomfortably high for Banxico which, in its first policy meeting of the year, devoted much of its efforts to stressing that the balance of risks to inflation is still skewed to the upside given the labour market remains strong and the economy still operates with positive output and labour market gaps despite the moderation of growth in 4Q23.
On balance, the latest inflation data and the emphasis placed on upside inflation risks in Banxico’s first policy decision this year leads us to believe that the first rate cut won’t take place until May, although, with their guidance leaving the door open for March, we can’t completely rule out an earlier cut should February’s inflation data show renewed progress on disinflation.
Banxico was very clear in its latest policy statement that risks to its inflation outlook remain tilted to the upside. The statement emphasised the disappointing dynamics of non-core inflation, which rose by 2.4% in January and could continue to positively contribute to inflation due to geopolitical risks and weather conditions. Experts are already placing a lot of the blame on the El Niño phenomenon, as not only does it often lead to poor maize harvests in Central America, but torrential rains also drive energy commodity inflation, while goods inflation can also be triggered by seasonally low water levels in the Panama Canal, for example. With this latent risk, and in line with recent inflation dynamics, Banxico policymakers revised upwards their overall near-term trajectory and now forecast 4.7% inflation in 1Q24, up from 4.3% previously, while keeping their year-end forecast intact at 3.5%. Upside risks to inflation weren’t just isolated to non-core components, however. Banxico also noted greater-than-expected resilience and FX depreciation as an upside risk, both of which suggest policy easing could be determined by the timing and pace of Fed easing. If true, this further confirms our view that Banxico won’t move until May, with the Fed likely to cut at the start of May under our base case. On a more optimistic note, core inflation was revised down from 4.7% to 4.6%, but the marginal downgrade highlights the lack of confidence in overall disinflation.
While the evolution of core inflation is showing a more favourable behaviour for Banxico’s expectations, the three-month annualised rate shows that the strengthening of the headline rate could put at risk the advance of inflation in Mexico
While the revisions to inflation expectations and the explicit recognition of upside risks were a differentiating factor in this decision, the change in tone was also notable.
Guidance was changed from “the policy rate should remain at its current level for some time” to “(the Board of Governors) will “begin to assess the possibility of adjusting the benchmark rate subject to available information”, implying that they will closely monitor upcoming data releases to finally decide the starting date of the normalisation cycle of their monetary policy. In our view, this means that while a March cut is definitely an option, the results of the February inflation report will determine whether this is the date finally chosen, or whether they are leaning towards a cut in the second quarter, probably in May. On the other hand, the statement refers to the Governing Board’s ongoing monitoring of the impact of the tight monetary policy stance on the inflation path on which monetary policy operates. Our read is that Banxico is more vigilant than ever on the strength of the ex-ante rate, currently at 7.5%, to determine the effectiveness of monetary policy transmission, especially after the weak Q4 growth data.
Finally, Banxico’s mention of currency depreciation as an upside risk to inflation does not suggest that they could align their easing cycle with the Fed’s, in a similar way as they did with the tightening cycle.
In summary, after January’s inflation data and Banxico’s first policy meeting in 2024, we believe that intentions and concerns are becoming clearer. Given its guidance and revised inflation forecasts, we believe Banxico is more likely to delay any easing until the second quarter, but hasn’t completely rule out a March cut should February’s inflation data show a marked improvement. Should the data confirm our base case of cuts being delayed until Q2, MXN is likely to remain one of the most defensive EM currencies in this latest wave of broad USD appreciation.
Author:
María Marcos, FX Market Analyst