August, 212
Outline 1. External Conditions 2. Economic Activity in Mexico 3. Monetary Policy and Inflation Determinants. Forecasts and Balance of Risks
External Conditions Global economic growth slowed down during the second quarter of the year: In the U.S., a more modest than anticipated recovery was observed and job creation has not been able to consolidate. In the Euro zone, the negative feedback loop among the weakening of economic activity, banks vulnerability and the difficult access of some governments to financial markets has accentuated. The economic performance in some emerging economies has slowed down significantly. In this context, most countries anticipate the following: Inflation levels in 212 and 213 below those registered in 211 and very low levels of inflation in advanced economies. Even more accommodative monetary policy stances, resulting in unprecedented levels of lassitude. 3
Prospective indicators point to a lower dynamism of the world economic activity. Manufacturing Purchasing Managers Index (PMI) (Diffusion index; s.a.) 6 Selected Economies: GDP Growth Forecasts for 212 (Annual % change) 1 9 55 8 5 5 U.S. Japan China Euro Zone Brazil Mexico 7 6 5 World Advanced Emerging 35 3 2 1 Jan 7 Jul 7 Jan 8 Jul 8 Jan 9 Jul 9 Jan 1 Jul 1 Jul 11 Jul 12 s.a./ Seasonally adjusted. Source: Prepared by Banco de México with data from International Monetary Fund, Institute for Supply Management, and Markit. 3 Jun 11 Jul 11 Aug 11 Sep 11 Oct 11 Nov 11 Dec 11 Feb 12 Mar 12 Apr 12 May 12 Jun 12 Jul 12 Aug 12 Source: Blue Chip. 1
In the U.S., industrial production growth has moderated and job creation has not consolidated. U.S.: Industrial and Manufacturing Production (Index Jan 27=1; s.a.) Total Manufacturing 15 1 U.S.: Non farm Payroll Monthly Change (Thousand jobs; s.a.) 3 25 95 2 15 9 1 85 5 8 Jan 8 Jun 8 Nov 8 Apr 9 Sep 9 s.a./ Seasonally adjusted. Source: U.S. Federal Reserve. Feb 1 Jul 1 Dec 1 May 11 Oct 11 Mar 12 Jun 12 Feb 11 Mar 11 Apr 11 May 11 Jun 11 Jul 11 Aug 11 Sep 11 Oct 11 Nov 11 Dec 11 Feb 12 Mar 12 Apr 12 May 12 Jun 12 Jul 12 s.a./ Seasonally adjusted. Source: Bureau of Labor Statistics. 5
In the Euro zone, the deleveraging process and absence of a definite solution to fiscal and banking problems have weakened economic activity. Euro Zone: Consumer Confidence (Diffusion index; s.a.) 2 Euro Zone: Credit of Financial Institutions to Private Sector (Annual % change; s.a.) 1 12 1 2 8 6 Euro Zone Greece Italy Portugal Spain Germany France 6 8 1 2 2 Jan 7 Jul 7 Jan 8 Jul 8 Jan 9 Jul 9 Jan 1 Jul 1 Jul 11 Jul 12 Jan 7 Jun 7 Nov 7 Apr 8 Sep 8 Feb 9 Jul 9 Dec 9 May 1 Oct 1 Mar 11 Aug 11 Jun 12 s.a./ Seasonally adjusted. Source: European Commission. s.a./ Seasonally adjusted. Source: European Central Bank. 6
International financial market conditions have deteriorated, registering high volatility given intensified difficulties in the Euro zone. Germany Spain France Italy Portugal Mexico Credit Default Swaps 1/ (Basis points) 8 Dec 11 29 Jun 12 1,6 1, 1,2 1, 8 Euro Zone: Exchange Rate 2/ (Dollars per euro) 8 Dec 11 29 Jun 12 1.6 1.5 1. 6 1.3 Jan 1 May 1 Sep 1 May 11 Sep 11 May 12 Aug 12 2 1/ 5 year CDS. On December 8, the ECB announced unconventional measures. On June 29, 212 reforms to strengthen the institutional framework of the euro area and support mechanisms were announced. Source: Bloomberg. Jan 1 May 1 Depreciation against USD Sep 1 May 11 Sep 11 May 12 7Aug 12 2/ On December 8, the ECB announced unconventional measures. On June 29, 212 reforms to strengthen the institutional framework of the euro area and support mechanisms were announced. Source: Bloomberg. 1.2 1.1
Emerging economies faced greater volatility in their capital flows and, in general, a depreciation of their currencies during the second quarter. Emerging Economies: Accumulated Capital Flows (Debt and Equity) (Billions of dollars) 28 29 21 211 212 1 7 1 13 16 19 22 25 28 31 3 37 3 6 9 52 Weeks 12 1 8 6 2 2 6 8 Jan 8 Jun 8 Nov 8 Emerging Economies: Exchange Rate 1/ (Index 1 Jan 28=1) Apr 9 Sep 9 Feb 1 Brazil Chile Colombia Korea Mexico Depreciation against USD Jul 1 Dec 1 May 11 8 Dec 11 Oct 11 29 Jun 12 Source: Emerging Porfolio Fund Research. 1/ On December 8, the ECB announced unconventional measures. On June 29, 212 reforms to strengthen the institutional framework of the euro area and support mechanisms were announced. Source: Bloomberg. Mar 12 Aug 12 17 16 15 1 13 12 11 1 9 8 8
As a result of the world economic slowdown, main commodity prices, with the exception of grains, decreased significantly. International Price of Crude Oil 1/ (Dollars per barrel) International Price of Grains 2/ (Dollars per bushel) Brent WTI 1 13 1.8% 12 Corn Wheat 1 12 1 11 18.6% 1 9 3.3% 8.5% 6 8 7 2 Jan 1 May 1 Sep 1 May 11 Sep 11 May 12 Aug 12 1/ The figure in brackets represents the percent change from the peak reached in 211. Source: Bloomberg. 6 Jan 1 May 1 Sep 1 May 11 Sep 11 May 12 Aug 12 2/ The figure in brackets represents the percent change from the peak reached in 211. Source: Bloomberg. 9
Most countries anticipate lower inflation levels in 212 and 213 as compared to 211 and very low levels in the case of advanced economies. World Advanced Emerging World Inflation (Annual %) Forecast 1 9 8 7 6 5 3 2 1 2 21 22 23 2 25 26 27 28 29 21 211 212 213 Source: International Monetary Fund. 1
Outline 1. External Conditions 2. Economic Activity in Mexico 3. Monetary Policy and Inflation Determinants. Forecasts and Balance of Risks
Productive activity and external demand presented a favorable evolution. 185 175 165 Economic Activity Indicators 1/ (Index 23=1; s.a.) Total IGAE Industrial production Services IGAE Agricultural IGAE (left axis) 1 135 13 Total U.S. Others Manufacturing Exports by Region of Destination (Index 27=1; s.a.) 19 17 155 125 15 15 135 12 115 13 125 11 11 115 15 15 1 9 95 95 7 Jan 7 Jun 7 Nov 7 Apr 8 Sep 8 Feb 9 Jul 9 Dec 9 May 1 Oct 1 Mar 11 Aug 11 Jun 12 s.a./ Seasonally adjusted and trend data. 1/ Industrial production up to June 212. Total IGAE, services and agricultural data up to May 212. Source: INEGI. Jan 7 Jun 7 Nov 7 Apr 8 Sep 8 Feb 9 Jul 9 Dec 9 s.a./ Seasonally adjusted and trend data. Source: Banco de México. May 1 Oct 1 Mar 11 Aug 11 Jun 12 12
Private consumption continued its positive trend, supported, among other factors, by bank credit. Commercial Establishments Sales (Index 28=1; s.a.) Wholesale Retail 17 15 13 11 99 97 95 93 91 89 Consumer Confidence (Index Jan 23=1; s.a.) 115 11 15 1 95 9 85 8 75 Commercial Banks Performing Credit for Consumption (Real annual % change) Total Credit cards Durable goods 1/ Payroll and others 2/ 5 3 2 1 1 2 3 87 7 Jan 7 May 7 Sep 7 Jan 8 May 8 Sep 8 Jan 9 May 9 Sep 9 Jan 1 May 1 Sep 1 May 11 Sep 11 May 12 Jan 5 Jul 5 Jan 6 Jul 6 Jan 7 Jul 7 Jan 8 Jul 8 Jan 9 Jul 9 Jan 1 Jul 1 Jul 11 Jul 12 Jan 8 Oct 8 Jul 9 Apr 1 Oct 11 Jun 12 s.a./ Seasonally adjusted and trend data. Source: INEGI. s.a./ Seasonally adjusted and trend data. Source: INEGI and Banco de México. 1/ Includes credit for the acquisition of property and automobile credits. 2/ Others refers to personal credits, credit for payable leasing operations and other consumption credits. Source: Banco de México. 13
Gross fixed investment and domestic financing to nonfinancial private firms keep expanding. 22 2 18 Investment and its Components (Index 25=1; s.a.) Total Construction National machinery and eqpt. (left axis) Imported machinery and eqpt. (left axis) 155 15 135 Domestic Financing to Non financial Private Firms (Real annual % change) Total Credit Issuance 35 3 25 2 16 125 15 1 1 115 5 12 15 5 1 95 1 8 85 15 Jan 7 May 7 Sep 7 Jan 8 May 8 Sep 8 Jan 9 May 9 Sep 9 Jan 1 May 1 Sep 1 May 11 Sep 11 May 12 Jan 7 Jun 7 Nov 7 Apr 8 Sep 8 Feb 9 Jul 9 Dec 9 May 1 Oct 1 Mar 11 Aug 11 Jun 12 s.a./ Seasonally adjusted. Source: INEGI. Source: Banco de México. 1
Outline 1. External Conditions 2. Economic Activity in Mexico 3. Monetary Policy and Inflation Determinants. Forecasts and Balance of Risks
Monetary Policy and Inflation Determinants The Board of Governors maintained the Overnight Interbank Interest Rate at.5 percent during the period analyzed in this, taking into account that: The economic activity continues its positive trend. The output gap practically closed, although no pressures on prices in the input markets, nor on external accounts are perceived. The impact of relative price adjustments on inflation, given exchange rate adjustments, has been moderate and is expected to be temporary. The non core inflation rebound is anticipated to be temporary. These relative price adjustments are expected to remain without causing second round effects on the price formation process. 16
The increase in annual headline inflation in the second quarter of the year was mainly due to higher inflation in the non core price index. CPI Core Non core Consumer Price Index (Annual % change) 12 11 1 9 8 7 6 5 3 2 1 Jan 6 Aug 6 Mar 7 Oct 7 May 8 Dec 8 Jul 9 Feb 1 Sep 1 Apr 11 Nov 11 Jun 12 Source: Banco de México and INEGI. 17
Within core inflation, the increase in the relative price of merchandise as compared to services has continued. Subindices of Core Merchandise Prices (Annual % change) 1 9 8 7 Subindices of Core Services Prices (Annual % change) Services Housing Education (tuition) Other services 1 9 8 7 CPI CPI Excluding Food and Energy 1/ (Annual % change) CPI excluding food and energy 1 9 8 7 6 6 6 5 5 5 3 3 3 Merchandise Food, beverages and tobacco Non food merchandise Jan 6 Aug 6 Mar 7 Oct 7 May 8 Dec 8 Jul 9 Feb 1 Sep 1 Apr 11 Nov 11 Jun 12 2 1 Jan 6 Aug 6 Mar 7 Oct 7 May 8 Dec 8 Jul 9 Feb 1 Sep 1 Apr 11 Nov 11 Jun 12 Source: Banco de México and INEGI. Source: Banco de México and INEGI. 1/ Excluding food at home (raw and processed foods and nonalcoholic beverages), food outside home, and energy. Source: Banco de México and INEGI. 2 1 Jan 6 Aug 6 Mar 7 Oct 7 May 8 Dec 8 Jul 9 Feb 1 Sep 1 Apr 11 Nov 11 Jun 12 2 1 18
The output gap practically closed, being at levels close to zero. Output Gap 1/ (% of potential output; s.a.) 8 Jan May Sep GDP 2/ IGAE 2/ Jan 5 May 5 Sep 5 Jan 6 May 6 Sep 6 Jan 7 May 7 Sep 7 Jan 8 May 8 s.a./ Calculated with seasonally adjusted data. 1/ Estimated using the Hodrick Prescott (HP) filter with tail correction method; See Banco de México (29), April June 29, p.69. The shaded area is the 95% confidence interval of the output gap, calculated with the unobserved components method. 2/ GDP figures up to the first quarter of 212; IGAE up to May 212. Source: Calculated by Banco de México with data from INEGI. Sep 8 Jan 9 May 9 Sep 9 Jan 1 May 1 Sep 1 May 11 Sep 11 May 12 6 2 2 6 8 1 12 1 19
However, no labor cost related pressures on prices are observed. IMSS insured Workers 1/ (Million workers) Original Seasonally adjusted Jan 7 Jul 7 Jan 8 Jul 8 Jan 9 Jul 9 Jan 1 Jul 1 Jul 11 Jul 12 1/ Permanent and temporary workers in urban areas. Source: IMSS and seasonally adjusted by Banco de México. 16. 15.8 15.6 15. 15.2 15. 1.8 1.6 1. 1.2 1. 13.8 13.6 13. National Unemployment Rate (%; s.a.) Jan 5 Aug 5 Mar 6 Oct 6 May 7 Dec 7 Jul 8 Feb 9 Sep 9 Apr 1 Nov 1 Jun 11 Jun 12 s.a./ Seasonally adjusted. Source: National Employment Survey (Encuesta Nacional de Ocupación y Empleo), INEGI. 7 6 5 3 2 Productivity and Unit Cost of Labor Force in the Manufacturing Sector (Index 28=1; s.a.) Unit cost Productivity Jan 7 May 7 Sep 7 Jan 8 May 8 Sep 8 Jan 9 May 9 Sep 9 Jan 1 May 1 Sep 1 May 11 Sep 11 May 12 s.a./ Seasonally adjusted and trend data. Source: Prepared by Banco de México with seasonally adjusted data from the Extended Industry Survey (Encuesta Industrial Ampliada), INEGI. 18 16 1 12 1 98 96 9 92 9 88 86 2
Inflation expectations have remained anchored. Inflation Expectations for the End of 212 (%) Headline Core Non core 5.5 5. Headline Inflation Expectations (%) 5..5. Break even Inflation and Inflationary Risk 1/ (%) 5.5 5..5 3.5.5 3.. 2.5. Jan 1 Apr 1 Jul 1 Oct 1 Apr 11 Jul 11 Oct 11 Apr 12 Jul 12 Source: Banco de México s survey. 3.5 3. End 213 Next years Next 5 8 years Variability interval Jan 1 Apr 1 Jul 1 Oct 1 Apr 11 Jul 11 Oct 11 Apr 12 Jul 12 2. 1.5 1. 1 year bond break even inflation 2 day moving average Jan 5 Aug 5 Mar 6 Oct 6 May 7 Dec 7 Jul 8 Feb 9 Sep 9 Apr 1 Nov 1 Jun 11 Aug 12 Source: Banco de México s survey. 1/ The break even inflation and inflationary risk implicit in 1 year bonds is calculated based on nominal and real interest rates of the secondary market. Source: Banco de México estimate with data from Bloomberg. 3.5 3. 21
Theexchangerateisexpectedtocontinueoffsettingpartof the depreciation registered at the beginning of the second quarter, period characterized by an increase in volatility. Exchange Rate and its Expectations for the End of 212 and 213 1/ (Pesos per dollar) Observed Expectations End 212 Expectations End 213 13.15 16 15 1 Implied Volatility in Foreign Exchange Options 2/ (%) 8 7 6 5 12.93 12.66 13 12 11 3 2 1 1 Mar 8 Nov 8 Jul 9 Mar 1 Nov 1 Jul 11 Mar 12 Aug 12 Mar 8 Aug 8 Jan 9 Jun 9 Nov 9 Apr 1 Sep 1 Feb 11 Jul 11 Dec 11 May 12 Aug 12 1/ The observed exchange rate is the daily FIX exchange rate. The latest data for the observed exchange rate is August 13, 212 and the foreign exchange rate forecasts is August 6, 212. Source: Banco de México and Banamex survey. 2/ Refers to one month options. Source: Bloomberg. 22
Reflecting solid macroeconomic fundamentals, domestic interest rates evolved favorably and government securities holdings abroad increased further. Interest Rates of Government Securities 1/ (%) 1 day 3 month 1 year 1 year 3 year 12 11 1 9 8 Mexico s Yield Curve (%) 3 Dec 11 29 Mar 12 29 Jun 12 13 Aug 12 9. 8.5 8. 7.5 7. 6.5 Government Securities Holdings by Foreign Investors (Billions of pesos) Bonds CETES 9 8 7 6 5 7 6. 6 5 5.5 5..5. 3 2 1 Jul 7 Feb 8 Sep 8 Apr 9 Nov 9 Jun 1 Aug 11 Mar 12 Aug 12 3 1 1 3 6 1 2 3 5 1 2 3 day months years 3.5 Jan 8 May 8 Sep 8 Jan 9 May 9 Sep 9 Jan 1 May 1 Sep 1 May 11 Sep 11 May 12 Aug 12 1/ Since January 21, 28, the one day (overnight) interest rate corresponds to the target for the Overnight Interbank Interest Rate. Source: Banco de México and Proveedor Integral de Precios (PiP). Source: Banco de México and Proveedor Integral de Precios (PiP). Source: Banco de México. 23
Monetary Policy and Inflation Determinants Based on the analysis of inflation determinants, no generalized pressures on prices in the economy have been observed. As previously forecast, the change in the relative prices of merchandise as compared to services has not contaminated the price formation process and this situation is expected to remain so. This forecast is primarily based on the following factors: The expectation of the nominal exchange rate to continue offsetting part of the depreciation registered at the beginning of the second quarter. Absence of generalized price adjustments by firms in response to exchange rate variations. Empirical evidence of a low exchange rate pass through to inflation. There have been some major adjustments in prices of some agricultural products, though their effect has been limited to a small group of commodities, and these adjustments are expected to reverse in the near future. 2
Outline 1. External Conditions 2. Economic Activity in Mexico 3. Monetary Policy and Inflation Determinants. Forecasts and Balance of Risks
GDP growth: Between 3.25 and.25% in 212. Between 3. and.% in 213. 9 8 7 6 5 3 2 1 1 2 3 5 6 7 8 9 Fan Chart: GDP Growth (Annual %; s.a.) Q2 Q Q2 Q Q2 Q Q2 Q Q2 Q Q2 Q 28 29 21 211 212 213 s.a./ Seasonally adjusted. Source: INEGI and Banco de México. Forecasts for the Mexican Economy: 211 Q 212 Q 213 Q 9 8 7 6 5 3 2 1 1 2 3 5 6 7 8 9 Increase in the number of IMSS insured workers: Between 5 and 6 thousand in 212. Between 5 and 6 thousand in 213. 7 6 5 3 2 1 1 2 3 5 6 7 Fan Chart: Output Gap 1/ (%) 211 Q Q2 Q Q2 Q Q2 Q Q2 Q Q2 Q Q2 Q 28 29 21 211 212 213 1/ Calculated with seasonally adjusted data. Source: Banco de México. 212 Q 213 Q 7 6 5 3 2 1 1 2 3 5 6 7 26
The worsening of the world economic outlook has led to a deterioration of the balance of risks for growth in Mexico as compared to the previous. Among the downward risks stand out : A weaker evolution of the U.S. economy. A new increase in uncertainty and financial volatility derived from fiscal and financial difficulties in the Euro zone. The situation in Europe could boost the investors search for safe haven assets, leading to a reduction in capital flows to economies like the Mexican. The slowdown of emerging economies could intensify the deterioration of global demand. 27
Headline inflation will most likely lie within an interval of 3 and percent in 212 and 213. Annual Headline Inflation (Annual %) Fan Charts Annual Core Inflation (Annual %) 7. 6.5 6. 5.5 5..5. 3.5 3. 2.5 2. 1.5 1..5. 211 Q 212 Q 213 Q 7. 6.5 6. 5.5 5..5. 3.5 3. 2.5 2. 1.5 1.5 Observed inflation Observed inflation 1. 1. Headline inflation target Headline inflation target.5.5 Variability interval Variability interval.. Q2 Q Q2 Q Q2 Q Q2 Q Q2 Q Q2 Q Q2 Q Q2 Q Q2 Q Q2 Q Q2 Q Q2 Q Q2 Q Q2 Q Q2 Q Q2 Q 26 28 21 212 26 28 21 212 7. 6.5 6. 5.5 5..5. 3.5 3. 2.5 2. 211 Q 212 Q 213 Q 7. 6.5 6. 5.5 5..5. 3.5 3. 2.5 2. 1.5 1..5. Source: INEGI and Banco de México. Source: INEGI and Banco de México. 28
The risks to the inflation forecast have changed in the recent quarter. In the short term, upward risks increased due to: Unfavorable climatic conditions for the production of some vegetables, and the possible effect of the avian influenza on livestock production in the country. Downward revisions of global production estimates for corn and other grains are also a matter of concern. The possibility of increased instability in financial markets that could induce exchange rate volatility. However, in the medium term, downward risks intensified: The possibility of a major weakening of both external and domestic demand increased. The recent exchange rate appreciation could contribute to reducing inflation pressures. 29
The recent monetary policy stance is conducive to attaining the 3 percent permanent inflation target. Even though inflation is expected to be above percent in the short term, the fact that the Central Institute has not modified the monetary policy stance should not be interpreted as a sign of indifference regarding an inflation increase. The movement of inflation above percent is due to transitory andreversiblefactors,soitisexpectedtoreturntolevelsbelow percent in a couple of months and, thus, to continue its convergence process to the 3 percent permanent target. Thus, restricting the monetary policy stance has not been considered as convenient. 3
The Board of Governors will remain attentive to all inflation determinants. In the future, the Board of Governors: Will continue to monitor the evolution of all inflation determinants, given that their performance could make it advisable to adjust the monetary policy stance to make it more or less restrictive, depending on the scenario that arises. In any case, it will pursue at all times the convergence of inflation to its 3 percent permanent target. Special attention will be paid so that relative price changes do not generate second round effects on inflation dynamics. These relative price changes derive from both agricultural products and exchange rate fluctuations. 31
It is necessary to strengthen the sources of domestic growth. The solid macroeconomic fundamentals are a necessary but not a sufficient condition to attain the growth rate Mexico requires to reach higher development levels. It is essential to also strengthen domestic sources of growth from a microeconomic perspective, which is particularly important in light of an unfavorable external environment. For that, it is necessary to bring forward structural reforms in the economy that: Promote flexibility in the country s resource allocation towards their most productive use. Increase competition in the markets. Secure an incentive structure that leads to increased productivity. 32