Mexico: Banco de Mexico lends support to the peso, but risks remain - BBH

Masahi Murata, Vice President at Brown Brothers Harriman is sharing his assessment of the Mexican economy:

"The Mexico economy has been sluggish as GDP growth fell to 2.3% in 2016 from 2.6% in 2015. The service industry remains steady, boosted by strong remittance inflow, but has been offset by weak manufacturing and construction. The mining sector continues to decline despite the rebound in oil prices. The economic outlook remains unclear. The likely renegotiation of NAFTA and potential implementation of tariffs on Mexican goods in the US should depress Mexican exports. The possible change in US immigration policy could weigh on remittance inflow to Mexico."

"Inflation pressures have risen due to the weak peso. February headline CPI rose to 4.9% y/y, above the upper range of the inflation target (2-4%) and the highest since March 2010. The Mexico central bank has kept a hawkish stance to stem inflation pressures and to help support the peso. It has hiked rates by 325 bp since December 2015. The bank is likely to continue tightening monetary conditions, as it estimates inflation to continue rising until it peaks at 5.0-5.5% in Q2."

"The Mexico government continues fiscal austerity in 2017. The public sector fiscal deficit is expected to fall slightly to 2.4% of GDP in 2017 from 2.6% of GDP in 2016. But lower growth and higher inflation could disrupt the government’s commitment to fiscal responsibility. It is likely to cut spending more than budgeted in order to remain in line with the fiscal targets."

"The Mexico central bank revealed it would start to auction as much as $20 billion in foreign-exchange hedges to support the peso without decreasing foreign reserves. Some media reported the bank was considering requesting a swap line with the Fed to ensure adequate liquidity, although Governor Carstens denied it. The officials could announce new measures to support the peso if it comes under pressure again".

"Weak fundamentals will persist in Mexico with a sluggish economy due to tightened monetary policy and fiscal austerity. Mexico’s trade account is unlikely to improve given uncertainties with respect to the US administration."