Outlook for the Mexican Economy

Outlook for the Mexican Economy October 5th, 2017

Outline 1

Monetary Policy and Inflation

2

External Conditions

3

Evolution of the Mexican Economy

4

Forecasts and Final Remarks

Outlook for the Mexican Economy

1

Conduction of Monetary Policy

 In recent years, the Mexican economy has experienced a number of shocks of considerable magnitude, that have caused inflation to reach levels above 6.0 percent in annual terms, after having reached a historic low level in late 2015:  Diverse external shocks that led to a depreciation of the national currency since late 2014.  The effects of the liberalization process of some energy prices this year.  The increase in the minimum wage last January.  In the last months increments in public transport fares in some cities, and, more recently, in the prices of some agricultural products.

In this context, Banco de México has implemented a timely strategy, taking the necessary measures for the adjustments in relative prices to take place in an orderly manner; that is, with medium- and long-term inflation expectations remaining anchored.

Outlook for the Mexican Economy

2

During 2017, Banco de México’s Board of Governors has raised the reference rate to a level of 7.0 percent.

These decisions were aimed to: February 2017

50bp increase to 6.25 percent.



March 2017

25bp increase to 6.50 percent.



May 2017

25bp increase to 6.75 percent. 

June 2017

25bp increase to 7.0 percent.

Avoid contagion in the process of price formation in the economy, and anchor inflation expectations.

Reinforce the actions implemented by Banco de México since 2015 in order to anchor inflation expectations.

Create conditions for the inflation to converge to its 3 percent target by the end of 2018.

These decisions considered that: August 2017

Unchanged at 7.0 percent.



September 2017

Unchanged at 7.0 percent.



Despite the persisting upward trend in inflation, it seems to have reached a peak.

Based on the information available at that moment, the level of the reference rate appeared to be congruent with the headline inflation convergence to its 3.0 percent target in late 2018.

→ These decisions took into consideration that monetary policy actions affect inflation with a considerable lag.

Outlook for the Mexican Economy

3

Thus, since December 2015, this Central Institute has increased the target for the overnight interbank interest rate by 400 basis points. With this, Banco de MĂŠxico has been one of the central banks that have tightened monetary policy stance the most in recent years.

Monetary Policy Rate and Consumer Price Index % and annual % change

10

9

Target for the Overnight Interbank Interest Rate 1/

8 7 6

Headline Inflation 5

Core Inflation 4 3 2

2017

2016

2015

2014

2013

2012

October 1F-September

2011

2010

2009

2008

2007

2006

2005

2004

2003

Headline Inflation Target

1/ Before January 20, 2008 it refers to the observed Overnight Interbank Interest Rate.

2/The upper limit of the target range is showed.

Source: INEGI and Banco de MĂŠxico.

Outlook for the Mexican Economy

4

This fundamentally constitutes a withdrawal of the monetary stimulus that prevailed during the previous period, as the current short-term ex-ante real rate appears to be close to the neutral level that is expected to be observed in the long term.

Short-Term Ex-Ante Real Rate and Estimated Ranges for the Short-Term Neutral Real Rate in the Short and Long Terms 1/ % 8 7 6 5 4

Short-Term Neutral Real Rate Range in the Long-Term Short-Term Neutral Real Rate Range in the Short-Term

3

2

Short-Term Ex-Ante Real Rate

1 0 -1

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

October

1/ It is constructed using the Target for the Overnight Interbank Interest Rate and 12-month inflation expectations from Banco de MĂŠxico Survey.

Source: Banco de MĂŠxico.

Outlook for the Mexican Economy

5

-2

Conduction of Monetary Policy Considering that adjustments in the monetary policy have a lagged effect on inflation, the monetary policy actions that have been implemented have started to be reflected in inflation, which has recently presented certain reversion in its trend.

ďƒź In this sense, it stands out that the items affected by the initial shocks already present a change in trend: most energy prices decreased and non-food merchandise have started to stabilize.

Considerable appreciation of the national currency against the U.S. dollar over the last months, a deceleration of credit demand in the economy, as well as the anchoring of inflation expectations should be highlighted, as they are some of the most important monetary policy transmission channels.

Outlook for the Mexican Economy

6

Indeed, albeit headline inflation remains at high levels, it seems to have reached a peak in August.

Consumer Price Index Annual % change

13 12 11 10

Non-core

9 8 7 6 5

Headline

4 3 2

Core

Variability Interval

1 0

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

1F-September

Source: Banco de MĂŠxico and INEGI.

Outlook for the Mexican Economy

7

In this sense, different CPI indicators suggest an improvement in the inflationary process.

Headline Inflation CPI and Trimmed Mean Indicator 1/ Annual % change

Seasonally Adjusted Annualized Monthly Change and Trend %, s. a.

21

Annual Inflation

18

Annualized Monthly Change

7

6.53 6

15

Trimmed Mean Indicator 4.69 5

12 4

9

6-month Moving Average

6

3

Headline Inflation Target

3

2

0 1

Headline Inflation Target

-3

s. a. / Seasonally adjusted data.

Source: Seasonally adjusted by Banco de México with data from Banco de México and INEGI.

0

2017

2016

2015

2014

2013

2012

2011

1F-September

2010

-6

2009

2017

1F-August

1F-September

2016

2015

2014

2013

2012

1F-September

1/ The Trimmed Mean Indicator excludes the contribution of extreme variations in the prices of some generic items from the inflation of a price index. To eliminate the effect of these changes, we conduct the following procedure: i) monthly seasonally adjusted changes of the generic items of the price index are arranged from the smallest to the largest value; ii) generic items with the biggest and the smallest variation are excluded, considering in each distribution tail up to 10 percent of the price index basket, respectively; and iii) using the remaining generic items, which by construction lie closer to the center of the distribution, the Trimmed Mean Indicator is calculated.

Source: Prepared by Banco de México with own data and data from INEGI.

Outlook for the Mexican Economy

8

Even though non-core inflation remains at high levels, it has recently receded as a consequence of a partial reversion in the prices of some agricultural products.

Consumer Price Index Annual incidences in percentage points 1/ 35

7

Merchandise Services Agriculture Energy and Government Approved Fares

30 25 20 15

Headline

5

3

0 -5 -10

1 3

-15

0

-20

Source: Banco de México and INEGI.

2016

2015

2014

2013

2017

1F-September

-25

2012

2017

2016

2015

2014

2013

2012

1F-September

4

1/ In some cases the sum of the respective components may have some discrepancy due to rounding effects.

Source: Elaborated by Banco de México with data from INEGI.

Outlook for the Mexican Economy

1F-September

-1

2017

LP Gas

6

5

2

2016

Urban Public Transportation

Headline without Tomato, Potato and Green Tomato

4

10

7

Headline without Tomato

2015

Energy

5

2014

Natural Gas

6.53 6.47 6.37

Headline

6

2013

Gasoline

Consumer Price Index Annual % change

2012

Transport Services and Selected Energy Prices Index Annual % change

Source: Banco de México and INEGI.

9

2

Even though inflation expectations for the end of 2017 derived from surveys kept observing upward adjustments, those corresponding to 2018 and 2019 have remained stable, which is still congruent with a transitory increase in inflation. Meanwhile, longer-term expectations remained anchored.

Headline Inflation Expectations Median, %

Annual Headline Inflation Expectations Median, %

4.5

7.0 6.5

4.0 6.0

2017

Next 4 Years Citibanamex 3-8 Years

5.5

3.5

Next 5-8 Years

5.0

3.0 4.5

Market Instruments 1/

2018

2.5

4.0 3.5

2019

September

1.5

2017

2016

2015

2.5

2014

Sep-17

Aug-17

Jul-17

Jun-17

May-17

Apr-17

Mar-17

Feb-17

Jan-17

Dec-16

Nov-16

Oct-16

Sep-16

Aug-16

Jul-16

Jun-16

May-16

Apr-16

Mar-16

Feb-16

Jan-16

2.0

3.0

September

Source: Banco de México Survey.

Variability Interval

1/ For a description of the estimation of log-term inflation expectations, see the Box “Decomposition of Break-even Inflation” in the Quarterly Report, October – December 2013.

Source: Banco de México Survey (monthly periodicity) and Citibanamex Survey (biweekly periodicity).

Outlook for the Mexican Economy

10

Since mid-January 2017 the Mexican peso has reduced its volatility and registered an appreciation. This has been largely a reflection of the monetary policy actions, an improvement in the perception of the bilateral Mexico-U.S. relationship during this period, and a more favorable international financial environment. Likewise, the actions implemented by the Foreign Exchange Commission contributed to improve the operating conditions in this market.

Nominal Exchange Rate 1/ Pesos per USD

Mexican Peso Volatility 2/ Pesos per USD

23

Exchange Rate (Last Data Oct, 4) 18.23 Analysts’ Expectation 2017 18.14 Analysts’ Expectation 2018 18.21

Jan-2016

30

U.S. Elections

27

22

24 21

21

Depreciation

18

20

15 19

12 9

18

6 17

1/ Observed exchange rate refers to the daily FIX Exchange Rate. Expectations refer to the average of Banco de México Survey from September.

Source: Banco de México.

Oct-17

Jul-17

Apr-17

Jan-17

Oct-16

Jul-16

Apr-16

Jan-16

Oct-15

Jul-15

Apr-15

Jan-15

Oct-14

Jul-14

October

Apr-14

16

Jan-14

Sep-17

Jul-17

May-17

Mar-17

Jan-17

Nov-16

Sep-16

Jul-16

May-16

Mar-16

Jan-16

October

3

Note: The black lines correspond to January 1st, 2016 and November 8, 2016.

2/ It refers to implied volatility in one-month options.

Source: Banco de México.

Outlook for the Mexican Economy

11

0

Short-term interest rates increased, reflecting increments in the reference rate, while longer-term ones declined in view of the anchoring of medium- and long-term inflation expectations in Mexico, the reduction in the inflation risk premium, the decrease in long-term U.S. rates and an environment of greater appetite for risk.

Interest Rates %

Yield Curve % 9.0

9

8.5 8.0

8

7.5

Oct 04, 2017

7.0

7

6.5

10 Year 6

2 Year

1 Day

Mar 31, 2017

6.0 5.5

Dec 30, 2016

5

5.0

1 Year

4.5

Sep 30, 2016

4

4.0

Dec 01, 2015

3 Month

3.5

3

3.0 2.5

Source: Banco de MĂŠxico and Proveedor Integral de Precios (PiP).

Sep-17

Jul-17

May-17

Mar-17

Jan-17

Nov-16

Sep-16

Jul-16

May-16

Mar-16

Jan-16

Nov-15

October

2

2.0 1 Day

1

3 6 Months

1

2

3

5 Years

10

20

30

Source: Banco de MĂŠxico and Proveedor Integral de Precios (PiP).

Outlook for the Mexican Economy

12

Outline 1

Monetary Policy and Inflation

2

External Conditions

3

Evolution of the Mexican Economy

4

Forecasts and Final Remarks

Outlook for the Mexican Economy

13

World economic activity kept expanding at a moderate rate across countries and regions.

This performance has been reflected in the favorable evolution of some indicators, such as international trade.

World Economy

GDP Growth 1/ Annual % change, s. a.

Trade of Goods 2/ Annual % change, s. a.

10

25 20

8

Emerging

15 6

Container Throughput Index 10

World

4

5

2

0

Trade Volume

-5

0

Advanced

-10 -2 -15 -4

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

s. a. / Seasonally adjusted data.

1/ The GDP calculation for 2Q-2017 includes estimates for some countries. The sample of countries used for the calculation represents 84.4% of world GDP measured by purchasing power parity.

Source: Prepared by Banco de MĂŠxico with information from Haver Analytics, J. P. Morgan and International Monetary Fund.

2017

July

-6

2006

2017

2015

2013

2011

2009

2007

2005

2003

2001

July

-20

s. a. / Seasonally adjusted data.

2/ It refers to the sum of imports and exports.

Source: Institute of Shipping Economics and Logistics, and CPB Netherlands.

Outlook for the Mexican Economy

14

-25

Meanwhile, global inflation has remained low in recent months. In most advanced economies, it persisted below their targets, due to lower energy prices, absence of wage-related pressures and, in some cases, decreases in some prices whose effects are considered transitory.

Headline Inflation Annual % change

Crude Oil Prices USD per barrel

10

125

Futures 1/ 8

115 105

WTI

95

6

85

Emerging

75 4 65

World

55

2

45 0

Advanced

25 -2

Note: The sample of countries used for the calculation represents the 83.2% of world GDP, measured by the purchasing power parity.

Source: Elaborated by Banco de MĂŠxico with data from Haver Analytics and IMF.

2018

2017

2016

2015

2014

2013

2012

2011

15 2010

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

August

2006

35

Mexican Oil Mix

1/ Data up to October 4th, 2017.

Source: Bloomberg.

Outlook for the Mexican Economy

15

U.S. GDP showed greater dynamism and its labor market kept strengthening. On the other hand, the consumption expenditures price index decreased, although this weakness could be transitory.

United States Real GDP and its Components Quarterly % change at annual rate and contributions in percentage points, s. a.

Total

Inflation and Unemployment Gaps %

Personal Consumption Expenditures Price Index and Inflation Expectations Annual % change

6

4.0

5

3.5

Inventories 4 Private Consumption

3.0

Public Expenditure

Natural Rate of Unemployment Gap

3

3.0

Inflation Expectations 1/

2.5

2.5 2.0

2.0

2

1.5 1

s. a. / Seasonally adjusted data.

Source: Bureau of Economic Analysis.

-3

-1.0

October August

Apr-17

Jan-17

Oct-16

Jul-16

Apr-16

Jan-16

Apr-15

-1.5

Note: Inflation gap refers to the PCE core component and is relative to the Federal Reserve 2% objective. Unemployment gap is relative to the natural rate of unemployment estimated by the CBO. Source: U.S. Department of Labor, Bureau of Labor Statistics; Congressional Budget Office (CBO).

Outlook for the Mexican Economy

0.5

Jan-15

2016

2015

2014

2013

2012

-4

2017

August

1.0

0.0

Oct-17

-0.5

PCE: Headline

Jul-17

-2

2011

2Q-2017

2017

2016

2015

2014

2013

Fixed Investment

0.0

Oct-15

-1

PCE: Core

0.5

Inflation Gap

Jul-15

0

Net Exports

1.5

1.0

1/ Expected inflation over the five-year period that begins five years from today.

Obtained from swap contracts in which one counterparty agrees to pay a fixed rate in exchange for receiving a referenced payment at an inflation rate over a specified period.

Source: Bloomberg and Bureau of Economic Analysis.

16

In this environment of persisting weakness of inflation and its expectations in advanced economies, it is expected a gradual withdrawal of the extraordinary monetary stimulus and then, slowly reaching a less accommodative stance. In this context, the Federal Reserve announced in its last meeting the beginning of the normalization of its balance sheet in October.

Federal Reserve: Balance Sheet 3/ USD Billions

Advanced Economies: Expected Monetary Policy Rates Implicit in OIS Curve 1/ %

Dic-18

Dic-17

Implied target rate in OIS curve October 4th, 2017 Implied target rate in OIS curve May 15th, 2017

2.0

4500

Forecast

4000

1.5

3500 1.0

Federal Reserve 2/

3000

Bank of England

0.5

ECB Main Refinancing Operations

2500

0.0 Bank of Japan

1/ OIS: Fixed-For-Floating swap where the fixed interest rate is the reference rate.

2/ Data for the observed federal funds rate corresponds to the average between the lower and upper bounds of the range (1.00% - 1.25%).

Source: Banco de MĂŠxico with data from Bloomberg.

2021

2020

2019

2018

2017

2016

2015

2014

2013

2012

1500

2011

Dec-18

Sep-18

Jun-18

Mar-18

Dec-17

Sep-17

Jun-17

Mar-17

Dec-16

Sep-16

Jun-16

Mar-16

Dec-15

Sep-15

Jun-15

Mar-15

Dec-14

Sep-14

Jun-14

Mar-14

-0.5

2010

ECB Deposit Facility

Dec-13

2000

3/ The forecasts are based on the median expected terminal value of the liabilities in the Federal Reserve balance sheet, which come from the Survey of Primary Dealers released in June 2017, assuming that the unwinding of the balance sheet starts in October 2017 as announced in the September 2017 FOMC meeting.

Source: Federal Reserve Bank of New York and Survey of Primary Dealers.

Outlook for the Mexican Economy

17

Outline 1

Monetary Policy and Inflation

2

External Conditions

3

Evolution of the Mexican Economy

4

Forecasts and Final Remarks

Outlook for the Mexican Economy

18

The Mexican economy kept expanding, even though it recently has shown a slightly slowdown.

Gross Domestic Product Quarterly % change, s. a.

4

1.5

0.6

0.7

1.0

0.7

1

0.1

0.4

0.4

0.6

0.9

0.6

0.7

0.5

1.0 0.5

0.4

0.2

0.4

0.9

1.1

2

0.7

0.8

1.5 0.9

1.0

0.8

0.9

1.4

1.3

1.7

0.5

0.2

2.1

3

-0.1

0

-1.0

-0.9

-1

-1.9

-2 -3

-5

2017

2016

2015

2014

2013

2012

2011

2Q-2017

2010

2009

2008

-3.9

-4

s. a. / Seasonally adjusted data.

Source: Mexico’s System of National Accounts, INEGI

Outlook for the Mexican Economy

19

Economic growth in 2017 kept reflecting the dynamism of the tertiary activities, while the stagnation that the industrial activity had been registering, persisted.

Global Indicator of Economic Activity Index 2008=100, s. a.

190

Industrial Activity Index 2008=100, s. a.

130

140

Electricity

Services 175

125

130

Total 160

120

145

115

Manufacturing Total

Industrial 130

120

110

110 100

115

105

100

100

Agricultural

Construction 90

Mining 80

95

2016

2015

2014

2013

2012

2011

2010

70

2017

July

90

2008

2016

2015

2014

2013

2012

2011

2010

2009

2008

s. a. / Seasonally adjusted data.

Source: Mexico’s System of National Accounts, INEGI

2017

July

70

2009

85

s. a. / Seasonally adjusted data.

Source: Monthly Industrial Activity Indicator, Mexico’s National Accounts System (SCNM), INEGI.

Outlook for the Mexican Economy

20

Manufacturing exports kept recovering, as a result of a gradual strengthening of the global activity and the accumulated depreciation of the real exchange rate.

Manufacturing Exports Index 2008=100, s. a.

by Destination

by Sector

170

150

U.S. Automotive

160

140

150 130

140

Total

130

120

Total

120

110

110

Others 100

100

Non Automotive

90

90

80

2016

2015

2014

2013

2012

2011

s. a. / Seasonally adjusted data based on information in nominal dollars Source: Banco de México with data from SAT, SE, Banco de México, INEGI. Merchandise Trade Balance, SNIEG. Information of National Interest.

80

2017

August

70

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

August

Source: SAT, SE, Banco de México, INEGI. Merchandise Trade Balance, SNIEG. Information of National Interest.

Outlook for the Mexican Economy

21

Private consumption kept registering a positive trend, even though it recently showed a certain slowdown. On the other hand, weakness of investment persisted.

Domestic Private Consumption Index 2008=100, s. a.

Investment and its Components Index 2008=100, s. a.

130

170

National Goods and Services

160 120

National Machinery and Equipment

Total Private Consumption

150 140

110

130 100

120

Imported Goods

Total 90

110 100

80

Imported Machinery and Equipment

70

Construction

90 80 70

s. a. / Seasonally adjusted data Source: Mexico’s System of National Accounts, INEGI.

2016

2015

2014

2013

2012

2011

2010

2009

2008

60

2017

July

60

2007

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

June

s. a. / Seasonally adjusted data Source: Mexico’s System of National Accounts, INEGI.

Outlook for the Mexican Economy

22

Credit to private sector has moderated.

Total Financing to the Non-financial Private Sector1/ Real % annual change

Total Credit Real % annual change 15

15

Domestic 2/

Households

10

5 4.4 2.7 1.3 0

Total

2/

12

Consumption

9

6

External -5 -6.9

Housing 3/ 3 2.7 2.6

-10

1/ Real annual changes are calculated based on balances adjusted due to exchange rate variations.

2/ These data are adjusted due to the withdrawal from and the incorporation of some financial intermediaries to the credit statistics.

Source: Banco de México.

0

Jul-17

Jan-17

Oct-16

Jul-16

Apr-16

Jan-16

Oct-15

Jul-15

Apr-15

Jan-15

Oct-14

Jul-14

Apr-14

Jan-14

Oct-13

Jul-13

Apr-17

August

-15

Aug-17

Apr-17

Dec-16

Aug-16

Apr-16

Dec-15

Aug-15

Apr-15

Dec-14

Aug-14

Apr-14

Dec-13

Aug-13

August

3/ Data are adjusted to prevent any distortions derived from the transfer and the reclassification of direct credit portfolio, by the transfer from the UDIS trust portfolio to the commercial banks’ balance sheet and by the reclassification of direct credit portfolio to ADES program.

Source: Banco de México.

Outlook for the Mexican Economy

23

The labor market seems to have no slack, even though this has not been reflected in wage pressures that could affect the inflationary process.

Output Gap 1/ % of potential output, s. a.

Employment Gap and Informal Salaried Workers 2/ Percentage points, s. a.

8 6

Productivity and Unit Labor Cost 3/ Index 2008=100, s. a.

105

4 3

100

4

2

GDP

Productivity

2 1

95

0 0 -2 -4

85 -3

s. a./ Calculated with seasonally adjusted data.

2/ The shaded area represents the confidence interval, which corresponds to two average standard deviations among all estimates; see Banco de México (2017), “Quarterly Report, October-December 2016”, pág.47.

Source: Banco de México.

Outlook for the Mexican Economy

80

2017

2015

2014

2013

2012

2011

2010

2009

2016

2Q-2017

-4

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2Q-2017

-10

2008

-8

s. a. / Calculated with seasonally adjusted data 1/ Estimated using the Hodrick-Prescott (HP) filter with tail correction method; see Banco de México (2009), “Inflation Report April-June 2009”, p. 69. The shaded area is the 95% confidence interval of the output gap, calculated with an unobserved components method.

Source: Calculated by Banco de México with data from INEGI.

Unit Labor Costs

-2

-6

July 2Q-2017

90

-1

2007

IGAE

Note: Data for 2Q-2017 estimated by Banco de México s. a./ Seasonally adjusted and trend series. The former is represented with a solid line, the latter, with a dotted line. Trends estimated by Banco de México.

3/ Productivity based on worked hours. Source: Unit cost prepared by Banco de México based on data from INEGI. The Global Index of Labor Productivity in the Economy (IGPLE), as released by INEGI.

24

Outline 1

Monetary Policy and Inflation

2

External Conditions

3

Evolution of the Mexican Economy

4

Forecasts and Final Remarks

Outlook for the Mexican Economy

25

Economic Activity Outlook GDP Growth

Fan Chart: Output Gap % of potential output, s. a.

(%) Report

Previous

Revised

2017

1.5 – 2.5

2.0 – 2.5

2018

1.7 – 2.7

2.0 – 3.0

4

2017 Q4

4

2018 Q4

3

3

2

2

1

1

0

0

-1

-1

-2

-2

Increase in the Number of IMSS-insured jobs (Thousands)

Report

Previous

Revised

2017

650 – 750

660 – 760

2018

640 – 740

670 – 770

Report 2017 2018

Current Account Deficit (% of GDP) Previous Revised 2.3 2.2 2.3 2.2

-3

-3

Observed Central Scenario August-17

-4

-4 Q2

Q4

2013

Q2

Q4

2014

Q2

Q4

2015

Q2

Q4

2016

Q2

Q4

2017

Q2

Q4

2018

s. a./ Seasonally adjusted data.

Source: Banco de México.

Outlook for the Mexican Economy

26

Risks to Growth Outlook The balance has deteriorated

Upward

Downward

That a successful renegotiation of the NAFTA triggers investment in areas of opportunity, which have not been previously considered by the Agreement.



That the NAFTA renegotiation does not render favorable results.



That the implementation of structural reforms renders greater-than-estimated results.



That higher volatility in international financial markets and the upcoming electoral process in Mexico reduce the sources of financing, affecting private spending.



That the oil production platform shows a more favorable performance.



That the increase in insecurity further affects productive activity.



Mexico has suffered two major earthquakes and several hurricanes, significantly affecting multiple communities and cities, with unfortunate human losses. It is estimated that the effects of these developments on economic activity will be temporary and moderate.

Outlook for the Mexican Economy

27

Headline Inflation

Core Inflation

2017

• It is expected to resume a downward trend in the last months of this year.

• It is anticipated to remain above 4.0 percent and at the end of the year to resume the trajectory of convergence to its target.

2018

Central Scenario for Inflation

• It is expected to decline considerably over the first months of 2018 and that it will accentuate its convergence to the 3.0 percent target.

• At the end of 2018, it is estimated to reach levels moderately above 3.0 percent.

Outlook for the Mexican Economy

28

The central forecast considers the monetary policy adjustments that have been implemented since December 2015, the vanishing of the base effect prompted by higher prices of various energy products at the beginning of 2017, an orderly behavior of the exchange rate, and a significant decrease in non-core inflation in the coming months.

8.0 7.5 7.0 6.5 6.0 5.5

Annual Headline Inflation 1/ Annual % change 2017 Q4

Variability Interval Headline Inflation Target Observed Inflation Central Scenario August-17 Analysts’ Expectations 2/

8.0

2018 Q4

7.5 7.0 6.5 6.0 5.5

5.0

5.0

4.5

4.5

4.0

4.0

3.5

3.5

3.0

3.0

2.5

2.5

2.0

2.0

1.5

1.5

1.0

1.0

0.5

0.5

0.0

0.0 Q2

Q4 2013

Q2

Q4 2014

Q2

Q4 2015

Q2

Q4 2016

Q2

Q4 2017

1/ Quarterly average of annual headline inflation.

2/ It refers to the median of monthly inflation expectations from the Survey of Private-sector Economic Analysts’ Expectations from Banco de México.

Source: Banco de México and INEGI. Outlook for the Mexican Economy

Q2

Q4 2018

29

It is expected that, in late 2017 and at the beginning of 2018, core inflation will resume its trajectory of convergence to the inflation target.

Annual Core Inflation 1/ Annual % change 8.0 7.5 7.0 6.5 6.0

8.0

2018 Q4

2017 Q4

Observed Inflation Central Scenario August-17 Headline Inflation Target Variability Interval

7.5 7.0 6.5 6.0

5.5

5.5

5.0

5.0

4.5

4.5

4.0

4.0

3.5

3.5

3.0

3.0

2.5

2.5

2.0

2.0

1.5

1.5

1.0

1.0

0.5

0.5

0.0

0.0 Q2

Q4

Q2

2013

Q4 2014

Q2

Q4 2015

Q2

Q4 2016

Q2

Q4 2017

Q2

Q4 2018

1/ Quarterly average of annual core inflation.

Source: Banco de MĂŠxico and INEGI.

Outlook for the Mexican Economy

30

Risks to the Inflation Outlook The balance could have deteriorated.

Downward

Upward



That the appreciation of the national currency consolidates and even deepens.



That energy prices decrease in accordance with their international references.



That some public fees don´t increase as they would have done under normal circumstances, or even decrease temporarily, as a result of recent natural disasters.



That the structural reforms lead to further reductions in different prices of the economy.



Albeit it has not occurred yet, that second round effects on inflation take place.



That the exchange rate is affected by some shock.



Higher-than-expected prices of agricultural goods.



Supply shortages or price increases in some goods derived from the recent earthquakes.



That the evolution of unit labor costs could start to be reflected in inflation.

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31

Monetary Policy Stance 

In this context, going forward the Board of Governors will closely monitor the evolution of all inflation determinants and its medium- and long-term expectations, especially:  The possible pass-through of exchange rate adjustments onto prices.  The evolution of the output gap.  The monetary position of Mexico relative to the U.S.  The impact of earthquakes on prices.

→ In any event, in light of different prevailing risks, the Board of Governors will be watchful to ensure that the monetary stance remains prudent, so that the anchoring of medium- and long-term inflation expectations is strengthened, and its convergence to the inflation target is achieved.

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Strengthening Confidence in the Mexican Economy 

It is important to keep in mind that the economy could face a highly complex environment, in particular, due to the possible tightening of global financial conditions, the evolution of the NAFTA negotiations and the upcoming electoral process in 2018.



In this context, it is especially relevant to persevere in maintaining strong macroeconomic fundamentals. In particular, to ensure that fiscal and monetary policies keep contributing to propitiate an orderly adjustment in the economy and in financial markets.  In this sense, the monetary policy actions implemented by Banco de México to maintain mediumand long-term inflation expectations anchored, as well as the commitment of the Federal Government to reach its fiscal goals for 2017 and 2018 should be highlighted.

→ These actions will contribute to reinforce the efficient convergence of inflation to its target.

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Strengthening Confidence in the Mexican Economy ď Ž

It is also necessary to strengthen the country's institutions at all levels so that they fulfill their social purpose under the principles of transparency and with zero tolerance on corruption.

ď Ž

In this sense, legal certainty and a strengthened rule of law will ensure the timely and correct implementation of the structural reforms and will correct the deficiencies that prevent the country from achieving a greater potential growth and higher competitiveness.

ď Ž

In this way, Mexico will be in a better position both to face the challenges it will have to cope with in the future, given the complex external and domestic environments, and to seize the opportunities that may arise.

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34