Mexican Peso: Bullish Trends Continue

We do not agree with this tightening scenario, but the slim possibility of higher rates in Mexico may work to support the peso. Headline CPI rose 3.94% year over year in mid-January, the high for this cycle and close to the top of the 2-4% target range. However, core CPI rose 3.3% year over year and has been in a 3.0-3.4% range for the past year.

The reason we remain skeptical of any near-term Banxico tightening is that the real sector data remains on the weak side. December trade data was just reported today, with export growth slowing to 8% year over year from 10% year over year in November and a 2011 peak of 29% year over year in January. Import growth also slowed to 7% year over year from 11% year over year in November, but this partially reflects a slowdown in imported components that are processed for export.

Domestic consumption is showing some signs of life, with ANTAD retail sales averaging 11% year-over-year growth vs. an average 5% year over year in the third quarter. GDP rose a stronger than expected 4.5% year over year in the third quarter, but monthly IGAE (a GDP proxy) has grown an average 3.75% year over year in October-November and points to some slowing in the fourth quarter. IMF sees Mexico growing 3.5% in both 2012 and 2013.

Banxico seems to recognize this too. After keeping rates steady at 4.5% this month, subsequent comments were very dovish. The bank said that the recent pickup in inflation was likely to be transitory, and that pass-through from a weak peso has been limited. Core inflation remains favorable. Labor and credit markets showing slack, with output gap closing at a slower pace than expected.

Lastly, it noted that the balance of risks for inflation is "neutral" but the balance of risk for growth is "deteriorating." This confirms our strong belief that any talk about a Banxico hike this year due to rising inflation should be discounted. We see rates on hold this year, with a bias towards easing if the economic outlook deteriorates. Bloomberg consensus is split over no move or a 25 basis-point cut in the first quarter, and shows a similar split in the second quarter as well.

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