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Summary of Mexico's Inflation Analysis

Core Content

This document provides an analysis of Mexico's inflation trajectory for 2018, focusing on the reasons behind the below-consensus forecast of inflation and its implications for the economy and currency.

Main Points of the Analysis

1. Inflation Forecast and Outlook

• CPI Forecast: BNP Paribas expects Mexico's CPI to decline to 3.5% y/y by year-end 2018, which is below the consensus of over 4%.
• Core Inflation: Core inflation is projected to finish at 3.3% y/y, significantly lower than the non-core CPI forecast of 6% y/y.
• Headline Inflation: The headline inflation is expected to approach the 4% upper bound by mid-2018, but still remain within the target range.

2. Key Drivers of Disinflation

• Weak Domestic Demand: Slower economic growth has contributed to lower inflation.
• FX Pass-Through: Lower FX pass-through and a marginally stronger peso have helped contain inflationary pressures.
• Monetary Policy: Tighter monetary policy and anchored inflation expectations have supported the disinflationary trend.
• Minimum Wage Increase: The 10% increase in minimum wage in December 2017 had a minimal impact on overall wage adjustments, aligning with expectations.

3. Non-Core Inflation Components

• Food Prices: The non-processed food prices are expected to mean-revert, and the impact of climatic conditions is not expected to be as severe as in 2017.
• Energy Prices: Although energy prices have been high, they are anticipated to moderate in the coming months, especially for LPG.

4. CPI Basket Adjustments

• The CPI basket weighting change in August 2017 is noted, but it is expected to have a limited impact on the year-end CPI number.
• The new weighting setup may magnify the effect of food price swings, but not enough to disrupt the overall disinflation trend.

5. FX and Currency Outlook

• The peso is less sensitive to inflation and more influenced by external developments such as NAFTA.
• The FX premium and carry adjusted by volatility are favorable, and the real effective exchange rate (REER) is ~20% below five-year levels.
• Any currency overshooting is expected to be short-lived, with the forecast for USDMXN at 18.00 by end-2018 and 17.50 by end-2019.

6. Impact of FX on CPI

• Unlike 2015-17, the peso is not expected to be a disruptive factor for inflation in 2018.
• FX pass-through is expected to have a significant but not overwhelming impact on CPI.

7. Risks to the Scenario

• Upward Risks: Negative outcomes for NAFTA or presidential elections could lead to peso appreciation, increasing import prices and potentially triggering protective actions.
• Downward Risks: These are considered less likely, but still present.

8. Comparison with Banxico's Scenario

• BNP Paribas forecasts lower CPI numbers than Banxico's scenario, which may ease pressure for additional interest rate hikes.
• The Banxico inflation report suggests a delayed convergence to the target range, while BNP Paribas believes actual numbers will be below the central bank's expectations.

Key Charts and Visual Aids

• Chart 1: Shows the forecasted headline and core CPI trends, with BNP Paribas' projections marked.
• Chart 2: Breaks down core and non-core inflation components and their expected behavior.
• Charts 3-5: Compare current account and FDI levels with the FX premium, volatility vs local yield, and REER.
• Chart 6: Compares end-2018 CPI simulations under different MXN setups.
• Chart 7: Contrasts BNP Paribas, consensus, and Banxico forecasts for inflation.

Conclusion

The analysis concludes that Mexico's inflation is expected to remain within the target range in 2018 due to a combination of weak domestic demand, subdued wage growth, and favorable FX conditions. The forecast is supported by both economic and monetary policy factors, and the outlook for the peso suggests that it will not significantly disrupt inflation dynamics. However, external risks such as NAFTA and election outcomes could introduce volatility and affect the inflation path.

Legal and Regulatory Disclaimer

This document is a marketing communication and not investment research. It is intended for Relevant Persons as defined under MiFID II and other regulatory frameworks. It is not a prospectus, public offering, or solicitation of an offer to buy or sell securities. The content may include Research for those who have signed up to BNPP's research packages. No guarantees are made regarding the accuracy or completeness of the information, and all estimates and opinions are subject to change without notice. BNP Paribas and its affiliates may have conflicts of interest and may engage in transactions inconsistent with the views expressed in the document.

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Additional Notes

• The document is produced by a BNP Paribas group company and is for the intended recipients only.
• It is strictly confidential and may not be reproduced or distributed without prior written consent.