Mexico: Changing gears – BNPP

Analysts at BNP Paribas are upgrading their 2017 real GDP growth call on Mexico by 0.5pp to 2.0%, on robust recent data, but as rate hikes will likely hit GDP growth, so they are cutting our 2018 GDP forecast to 1.5%.

Key Quotes

“Recent activity numbers suggest the Mexican economy is proving to be more resilient than had been expected. According to preliminary data released on 31 July, the economy grew 0.6% q/q in Q2 (1.8% y/y), faster than we had anticipated. In light of the robust numbers, including booming manufacturing exports, strong employment creation and fading worries on NAFTA renegotiations, we are upgrading our 2017 growth forecast to 2.0% from 1.5%.”

“But, while the near-term growth outlook has improved, we worry that the lagged impact from cumulative monetary tightening, in place since late 2015, will hit the economy more in 2018. Our econometric work on a monetary impulse response function suggests that the hit on real GDP growth from a policy rate hike is strongest about five quarters after the initial interest rate move.” 

“Therefore, the cumulative rate hike of 400bp implemented so far in the current tightening cycle should have its maximum cumulative impact on the economy in 2018, we believe. Thus, we are reducing our 2018 real GDP growth forecast to 1.5% from 2.0%.”

“The blow to GDP could be softened by developments like robust oil field auctions (and related investments) and a benign outcome from the NAFTA deal talks. Growth could suffer, however, if concerns increase about domestic factors, such as the mid-2018 presidential election, or external factors like potentially unfriendly US policies.”

“The first signs of the impact from monetary tightening on growth can already be seen in some parts of the economy. Credit concessions have slowed, retail sales have trended lower since early 2017 (despite a tight labour market) and investment has suffered. The effect on the economy should intensify into next year with a further reduction in credit concession growth, which we expect to enter into negative territory, and a sharp increase in corporate interest rates.”

“Fortunately, expected rate cuts during 2018 should support growth in 2019. As inflation should fall back towards the 3.0% centre of the target range next year, we believe, Banxico should have ample room to cut rates. We expect these cuts to begin in the first half of the year, earlier than the consensus view, as headline year-on-year inflation will likely fall by about 1.0-1.5pp in January, on favourable base effects. Also, we forecast rates to fall to 5.0% in 2018, below the latest consensus view of about 6.5%.”