EM Daily:Banxico,A volatility-triggered hike

Mexico’s Central Bank is scheduled to meet Thursday for the first time in 2018.

    Since December’s meeting and until last week, inflation risks in Mexico haddeclined. In particular, January’s Banxico Survey of Expectations released lastweek suggested the 25bp hike last December was followed by a marginal shiftof medium and long term inflation expectations towards the central bank’s 3%target. In particular, while inflation expectations for 2018 and 2019 stand ataround 4% and 3.5% respectively, respondents expect core inflation at year-endto reach 3.6% and 3.3% in 2018 and 2019. Also, prices during year’s first twoweeks dropped to 5.5% from the previous 6.85% print. Finally, with the USD/MXN ending last week at around 18.4 it seemed to us that the improved balanceof risks warranted Banxico remaining on hold in February to perhaps match theFed’s expected hike next March with an increase of rates in their April meetingalthough we recognized our call had significant risks to the upside (see EM Macroand Strategy Focus).

    Over the past few days, against a backdrop of heightened volatility in US equitymarkets and financial markets more generally the MXN has lost around 2.2% ofvalue against the USD. The Mexican economy’s low pass-through implies thatthe selloff does not materially threaten the improvement of the balance of risks toinflation, Banxico’s past behavior lead us to believe that the likelihood of Banxicodelivering a 25bp hike next meeting have increased significantly. And in our view,Banxico’s particular sensitivity to the MXN’s price action and the continuingturmoil will lead Mexico’s central bank to hike this time (especially after the 0.5%MXN selloff in the last hour of trading of the US equity market). Unless thereis a very large surprise to the downside when INEGI releases January’s inflation(consensus: 5.52% y/y, DB: 5.5% y/y) could sway Banxico’s board to keep the rateat 7.25% we think the likelihood Banxico stays on hold is now very small.