Mexico's central bank works to keep inflation in check

Having been plagued by chronic high inflation and periodic crisis until the mid-1990s, Mexico turned to economic liberalisation in the wake of the 1994-95 “Tequila crisis”. Among the important reforms was the granting of independence to the central bank, Banco de México (Banxico), in the operation of monetary policy, along with a clear mandate to control inflation above all other policy considerations. To this end, Banxico adopted an inflation target of 3% in 2003, with a margin for manoeuvre of plus or minus one percentage point. Effectively, this established a target range of 2-4%.

Over Time

From historic peaks of 180% in February 1988 and 52% in December 1995, according to Banxico figures, the annual inflation rate has been brought steadily under control. Since dropping into single digits in March 2000, it has remained there and declined to a low of 2.13% in December 2015, near the bottom of the target range. While relatively slow economic growth was an important factor in recent years, the deflationary impact of the telecom reforms (see Telecoms & IT chapter) has also played a key role. According to the Federal Institute of Telecommunications, telecoms prices fell by 23.2% between June 2013 and December 2015, whereas average prices increased by 9.1%.

From its low point in late 2015, core inflation climbed slowly and steadily throughout 2016 to surpass the 3% mid-point of Banxico’s target range, reaching 3.36% by the end of that year. Headline inflation rose to 4.86% in February 2017 as the authorities increased domestic prices of petrol and diesel by around 20%. Producer prices, which are more sensitive than consumer prices to the exchange rate, accelerated much more rapidly, rising by 8.51% over the course of 2016. In response, the central bank moved aggressively and pre-emptively to suppress inflationary pressure, raising interest rates by a total of 250 basis points.

On The Rise

There are a number of factors that are likely to see core inflation continue to rise over the remainder of 2017, potentially reaching 5%. Ahead of the liberalisation of retail prices for petrol and diesel across the country in 2017, the government announced in January 2017 that national maximum prices would increase by 15-20%, effectively ending government subsidies. As the year progresses, maximum prices are to be revised more often than previously, while fully liberalised market prices are expected to be rolled out countrywide by the end of 2017 (see Energy chapter). Additionally, while the weak peso did not have a large impact on consumer prices in 2016, the pass-through effect came to the fore towards the end of the year, particularly as the pace of depreciation picked up in the final two months of 2016. Continued peso weakness, as well as increased knock-on effects for consumer prices, is likely to continue through 2017.

In January 2017 Mexico’s minimum wage was raised by nearly 10%, from MXN73 ($4.40) to MXN80 ($4.82) per day. In recent years, the minimum wage had been increased in line with inflation. The impact on spending power is expected to support private consumption, and further contribute to inflationary pressure.

Hopeful Outlook

Nonetheless, Banxico and other observers remain confident that these effects are likely to prove transitory, that medium- to long-term inflation expectations remain anchored safely within the target range and that core inflation is likely to return to the middle of that range in 2018. In fact, the credibility that Banxico has attracted under the stewardship of Agustín Carstens is such that the central bank governor will be leaving his position to head up the Bank of International Settlements, located in Basel, Switzerland, for a fiveyear term beginning in October 2017.

While this certainly represents welcome recognition of Mexico’s conduct of monetary policy, it presents the country with a challenge. At a time of economic uncertainty, rising inflationary pressure and exchange rate volatility, it is important that the appointment of the new governor in July 2017 signals a commitment to effectively anchoring long-term inflation expectations.