Economics: New risks to the pace of inflation

MEXICO - Report 22 Jan 2018 by Mauricio González and Esteban Manteca

The unexpected high at which inflation ended in 2017 has sparked considerable discussion and concern due both to the extent and pace at which consumer prices have risen.

We at GEA have long reported on expectations of an acceleration owing to gains seen for some time in prices for diverse inputs and basic foods that were pressuring the prices paid by producers and consumers alike. That history now translates into further price growth expectations that are adding resistance to containing inflation. Given the slowness with which the authorities reacted to the problem in 2017, there is only a limited range of action at their disposal at this point, and that official inertia is now combining with unleashed inflation expectations.

One positive development has been the extent to which core inflation snapped a 21-month growth trend in August in a sign that price growth has begun to slow, at least with the exception of food and energy.

But the weakening of the peso had a significant effect on some prices, and the lack of visibility as to the future of Nafta and direction of a volatile peso is likely to further fan inflation expectations. With inflation outstripping wage growth for the first time in seven years, workers are expected to press for greater wage adjustments.

The substantial increase in public spending leaves the public sector with very a very rigid framework in which to work: debt is high, and spending cuts are not an option in an election year. Since they have opted for a combination of restrictive monetary and fiscal policies, there is little the authorities can do to contain prices, so we can expect them to engage in a lot more finger-pointing at those who dare to raise prices.

And while interest rate policy and dollar auctions have had limited effect to date, we expect Banco de México to maintain its restrictive stance and announce three more rate hikes before the end of the year starting on February 8, an approach that might help to lower inflation expectations.

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