Mexico’s Core CPI Dynamics (y/y, 2w/2w index)
Source: Banxico and RGE
In RGE’s view, the current inflation result is consistent with our assessment, that prices in Q1 2011 will be closer to the target by March; in response to a high base, strong currency and limited demand-pull pressures. However, as beneficial base effects wear off in Q2 2011, and the negative output gap continues to close—perhaps in Q3 2011—high commodity prices will likely have a stronger effect on local prices, pushing them above the 4% upper bound of the target range in Q3 2011, before a drop to 3.8% by year-end. The wild card is the behavior of agriculture prices. As stated in the past, we expect the central bank, Banxico, to stay on hold at 4.5% throughout the year and start the tightening cycle in January 2012, pushing the monetary policy rate to 5.5% by the end of next year. However, we do not discard the possibility that the central bank might act preventively in H2 2011, if the output gap closes sooner than expected and if inflation expectations deteriorate rapidly.
Editor’s Note: This post is excerpted from a much longer analysis available exclusively to RGE clients, Market Rates Continue to Trim Down in Brazil.