Mexico—Headline Inflation Surprised to the Downside But Core CPI Remained Sticky in January

Headline and core inflation in January came in at +0.23% m/m (6.28% y/y) and +0.43% m/m (5.76% y/y), respectively, according to Banxico.  The central bank target range for the 1Q09 is 5.75% y/y to 6.25% y/y.  The monthly headline print was well below our expectation (+0.35% m/m) and that of the Bloomberg and Reuters consensus (+0.33% m/m), while core CPI was in line with forecasts (Ours +0.44% m/m; Bloomberg and Reuters +0.43% m/m).


Non-core CPI continued decreasing sharply compared to a year ago because of a faster decline of inflation in the agricultural as well as in the administered and concerted categories.  A sharp drop in prices of fruits and vegetables (-4.1% m/m), in particular jitomates, onions and green tomatoes, drove agricultural inflation down.  Moreover, deflation in the administered component (-1.4% m/m), especially due to lower electricity and domestic gas tariffs, brought inflation in the administrative and concerted group into negative territory.  This is despite the higher prices in the concerted category (+1.4% m/m), chiefly driven by increases in bus fares, as well as water and phone services. This indicates that seasonal factors and administrative measures helped non-core inflation.


However, core CPI increased marginally compared to a year ago because lower prices in the services sector was not enough to compensate for higher inflation in the goods category.  Lower costs in housing (+0.3% m/m) and education (+0.23% m/m), coupled with a sharp decline in the “rest” sub-component (-0.21% m/m), pressured services prices down.  However, higher inflation of processed food (+1.1% m/m) and “others” (+0.55% m/m) impacted goods prices; therefore, keeping core inflation under upward pressure.


In our view, administrative measures, together with decelerating domestic demand and seasonal factors, continued exerting disinflationary pressures in January.  However, a sluggish transmission mechanism, meaning that sharply lower international commodity prices are not yet reflected in domestic prices, was likely exacerbated by a weaker MXN, and thus kept goods inflation elevated.  Moving forward, we anticipate inflation and inflation expectations to continue improving (3.7% y/y by year end) and the central bank to stay in the easing course, as the output gap keeps widening and international prices of food and fuel stay low.  Consequently, we expect the CB to cut the reference rate by 50bps in the February 20th meeting and to reach 6% by mid-year.  Our monetary policy path implies cuts of 50bps each in February and March, and reductions of 25bps each in April, May and June, consequently bringing the reference rate to 6%.  However, we do not discard the possibility that more aggressive easing might be performed if the inflation outlook improves dramatically. This is especially true for the next meeting, especially when we consider the dovish tone of the latest quarterly inflation report. In particular, we think that the rhetoric used by Banxico when discussing the potential pass-through from MXN/USD losses to inflation, together with the fact that inflation readings are practically moving towards the CB band for 1Q09, and the apparent effective way in which the authority has been intervening on the Forex market, add strength to a more aggressive 75bps cut in Feb 20th.