Mexico - Economic Briefing July 2005

Central Bank Ends Tightening Cycle

The economy continues to develop along a lower-than-expected expansion path, as the manufacturing sector is suffering from sluggish U.S. demand. However, the U.S. manufacturing industry seems to be exiting the soft patch from earlier this year, which could rekindle growth in Mexico. Meanwhile, inflation is declining notably, which has prompted the Central Bank to end the tightening cycle that lasted for more than a year.

Economic growth slumps in first quarter

A more complete data set for national accounts confirmed the 2.4% annual first quarter growth reported last month.  The reading represents a sharp deceleration compared to the 4.9% growth registered in the fourth quarter and confirms that the economy is struggling to get on a solid footing despite healthy growth in the U.S. economy.  In part, the first quarter reading was distorted by the Easter holiday effect, which was in first quarter this year but in second quarter last year.  As a result, the first quarter 2005 counted fewer working days than last year.  However, even adjusting for seasonal effects, the economy expanded at a similarly sluggish pace suggested by the annual data.  According to seasonally adjusted figures, the economy grew a paltry 0.43% growth over the preceding quarter. 

Domestic and external economy decelerate in unison

The deceleration compared to the fourth quarter affected the domestic economy and the external sector alike.  Total consumption expanded 4.8% over the same period last year, notably slower than the 6.0% expansion registered in the fourth quarter.  The deceleration was entirely concentrated in private consumption, which slowed from a 7.0% expansion in the fourth quarter to 5.4% in the first.  Government consumption, in contrast, improved, as the 0.9% contraction registered in the fourth quarter gave way to zero growth in the first quarter.  Investment deteriorated more notably.  In the first quarter, gross fixed investment added 6.5% over the first quarter 2004, compared to the 10.9% expansion recorded for the fourth quarter.  While the first quarter growth still looks solid on the first view, it ends a series of five consecutive accelerations in investment growth.  Moreover, in seasonally adjusted terms, investment actually dropped 0.43% over the preceding quarter, confirming suspicions that the expansion of the current investment cycle is drawing to an end.  The contribution of the external sector also deteriorated as exports decelerated at a quicker pace than imports. 

Economy develops below expectations

In April, economic activity increased 4.8% over the same month last year, according to the global indicator for economic activity (IGAE, Indicador Global de la Actividad Económica).  While the reading was above the barely positive 0.3% annual growth observed in March, growth remained below market expectations, which had the economy expanding at a faster pace given the above mentioned statistical effect resulting from the Easter holidays.  A month-on-month comparison confirms the disappointing annual data.  According to seasonally adjusted figures, the economy contracted 0.03% over the preceding month, continuing the trend of negative to flat growth already observed in the first three months of the year. 

Industrial sector rebounds and U.S. manufacturing moderately promising

In April, agriculture bounced back from the barely positive 0.2% expansion in March to 1.5% growth.  Similarly, growth in services almost doubled from 2.7% to 5.1% in April.  However, the most pronounced pick-up in growth actually occurred in the industrial sector, which bounced back from a 4.7% contraction in March to 5.2% expansion in April.  However, just as with overall economic growth, the industrial sector reading was spurred by extra working days compared to the same month last year.  According to seasonally adjusted data, total industrial output was flat over the preceding month and the all-important manufacturing industry even experienced a 0.07% contraction.  Moreover, the trend is pointing downward.  Annual average growth in the manufacturing industry, which had dropped from 4.0% in February to 3.0% in March only recovered one tenth of a percentage point to 3.1% in April.  However, the latest developments in U.S. manufacturing - the key driver of the Mexican manufacturing industry – are moderately encouraging.  The Institute for Supply Management (ISM) reports that the manufacturing sector grew for the 25th consecutive month in June.  Moreover, after six consecutive months of declines, the Purchasing Managers' Index (PMI) picked up from 51.4% in May to 53.8% in June.  A reading above the 50% threshold indicates that the manufacturing industry is expanding.  According to the June PMI report, stronger new orders and slower price increases in manufacturing represented the most positive signs in several months and indicate that the 'soft patch' is drawing to an end.  However, high energy costs and the stronger US$ still represent major concerns to the U.S. manufacturing industry.  Consensus Forecast panellists expect the Mexican industrial sector to grow 3.7% this year, accelerating slightly to 4.0% in 2006.

Outlook remains stable

The deterioration in the international setting and the recent sluggishness in economic activity do not bode well for the remainder of the year.  The leading and coincident indicators for April, published on 6 July, declined in unison for the second consecutive month.  The coincident indicator that tracks the current developments in the economy was down 0.43% over the preceding month in seasonally adjusted terms while the leading indicator that tries to anticipate future developments in the economy decreased 0.08% over the preceding month.  However, consumer confidence improved.  In June, the overall index of consumer confidence reached 100.7 points, up from 99.7 points in May.  The June reading ends a series of three consecutive months of declines.  In particular, the sentiment about purchasing decisions regarding durable consumer goods have improved markedly, suggesting that the relatively solid consumption growth could continue to support economic growth in the coming months.  However, the question remains whether ongoing consumption growth will be sufficient to stem the slowdown in the external sector.  In spite of the recent negative developments, Consensus Forecast panellists have maintained their forecasts for economic growth this year unchanged over last month at 3.7%.  However, the sentiment for next year deteriorated, as the Consensus Forecast for output growth dropped from 3.7% expected last month to the current 3.6%.

Consumer prices decline for second consecutive month in June

In June, consumer prices dropped 0.10%.  The actual rate contrasted market expectations, which had prices growing 0.10%, according to last month’s Consensus Forecast.  The June price drop was the second consecutive price  decline after prices had dropped 0.25% in May.  In the first four months of the year consumer prices had increased an average 0.29% per month.  Whereas lower prices for housing were the sole driver behind the May price decrease, notably lower price for food, beverages and tobacco pushed the June price level below the zero mark.   As a result of moderating prices in May and June, annual headline inflation dropped from 4.6% in April to 4.3% in June.  The core inflation index increased by 0.26% in June following on a 0.21% increase in May and annual core inflation fell from 3.5% in April to 3.4% in June.  Thus, even though headline inflation remains well above the upper limit of the Central Bank’s one percentage point tolerance around its 3.0% target rate, the core inflation rate is still within the established tolerance limits.  Consensus Forecast panellists expect headline inflation to overshoot the Central Bank’s target again this year, with a year-end rate reaching 4.2%.

Central Bank ends tightening cycle amid declining inflation trend

While inflationary expectations remain well above the Central Bank’s target rate, the benign trend of the core inflation rate, which steadily dropped from 3.8% at the end of last year to the 3.4% in June prompted the Central Bank to leave monetary policy unchanged on 24 June.  The decision fuelled expectations that monetary authorities will soon end the current tightening cycle, which had resulted in an increase of the money market "short" (corto) 12 times since February 2004.  An increase in the corto reduces overnight lending to banks and indirectly drives up interest rates.  Despite the increased evidence that monetary authorities intend to end the tightening cycle, the benchmark 28-day Cetes rate remained virtually unchanged during June at 9.61%.  Consensus Forecast panellists believe that the tightening has come to an end and expect the interest rate to drop to 9.0% by the end of the year, which is unchanged from last month’s forecast.

Exchange rate appreciated slightly versus the US$ in first half of 2005

The Mexican peso closed the first half of the year at 10.78 pesos versus the US$, which represents a nominal appreciation of 3.5% over the end of last year.  The period was characterized by erratic movements in the first quarter, which left the currency virtually unchanged.  The second quarter was characterized by a steady appreciation.   This year, Consensus Forecast panellists expect the peso to depreciate by 3.4% in nominal terms, closing the year at 11.55 pesos to the US$.  Next year, the Mexican peso is likely to lose ground further versus the US$, with the Consensus expecting a nominal depreciation of 3.7%, which will bring the exchange rate to 11.99 pesos to the US$ by year-end.