BANXICO - Monetary Policy Implementation During US Policy Normalization 10 de Octubre 2014.pdf

Monetary Policy Implementation During US Policy Normalization

JP Morgan Investor Seminar Washington, DC, 10 October 2014

1

Javier Guzmn Calafell, Deputy Governor, Banco de Mxico

2

Outline

Introduction 1

Beyond 2015 3


Monetary Policy in 2014-15 a. The External Environment b. Domestic Conditions

2

3

Since 2001, monetary policy in Mexico is implemented under an inflation targeting regime.

In this context:

A permanent inflation target of 3 percent, with a variability interval of +/- 1 percent, has been set.

A systematic analysis of inflation and its determinants is carried out, on the basis of a wide range of indicators and tools.

The efficient convergence of inflation to the target (i.e. at the lowest possible cost in terms of economic activity) is sought.


It is also worth noting that in the aftermath of the global financial crisis, the Banco de Mxico, in coordination with other authorities, is attaching increasing relevance to financial stability.

010

20

30

40

50

60

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

Headline inflation

Sep Introduction of inflation targeting

4

With the support of major efforts on the fiscal side, such a strategy has allowed continued progress in the reduction of inflation

Source: Banco de Mxico.

1/ Target for the overnight interbank interest rate adopted on 21 January 2008.

Headline Inflation and Overnight Interbank Interest Rate Annual %


0

1

2

3

4

5

6

7

8

9

20

08

20

09

20

10

20

11

20

12

20

13

20

14

Overnight interbank interest rate1/

Headline inflation

Sep

5

and to maintain stable medium and long term inflation expectations even in the presence of substantial shocks.

Inflation Expectations and Inflation Shocks Annual %

Sources: Banco de Mxico and INEGI.


0

2

4

6

8

10

12

14

16

-20

-10

0

10

20

30

40

50

60

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

Sep

Inflation Expectations: 12 months

2 years 4 years

MXN/USD Exchange Rate Fruits and Vegetables

6

Outline

Introduction 1

Beyond 2015 3

Monetary Policy in 2014-15 a. The External Environment

b. Domestic Conditions 2


7

Since Mexicos economy is very open, the implementation of monetary policy is heavily influenced by external developments.

Source: Own calculations with data from World Economic Outlook and Direction of Trade Statistics, IMF.

Trade Openness Exports and Imports as % of GDP, 2013

Financial Openness Chinn-Ito Index1/, 2012

1/ Measures a country's degree of de jure capital account openness (0-1 scale), based on the IMF's Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER).

Source: Chinn and Ito (2006) : "What Matters for Financial Development? Capital Controls, Institutions, and Interactions, JDE 81(1):163-192 (October).


0.69

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

Per

u

Ko

rea

Mex

ico

Ch

ile

Ru

ssia

Turk

ey

Po

lan

d

Bra

zil

Ind

on

esia

Co

lom

bia

Ind

ia

Ch

ina

S. A

fric

a

63.4

0

10

20

30

40

50

60

70

80

90

Ko

rea

Po

lan

d

S. A

fric

a

Mex

ico

Ch

ile

Turk

ey

Per

u

Ch

ina

Ind

on

esia

Ind

ia

Ru

ssia

Co

lom

bia

Bra

zil

U.S., 78.8

Canada, 2.8

Eurozone, 4.4

U.K., 0.4

China, 1.7

Japan, 0.6

Other, 11.4

8

The recent behavior of the world economy and its projected evolution for the rest of 2014 and in 2015 favors the expansion of Mexican exports.

Mexican Exports by Country of Destination % of Total, 2013

Source: INEGI.

Major Economies: Real GDP Index 4Q-2007 = 100, s.a.

s.a./ Seasonally adjusted. Source: Haver Analytics.


91

96

100

104

109

0

50

100

150

200

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

United States

United Kingdom

Japan

Eurozone

China

2Q 2014

9

In particular, analysts estimate US GDP growth above potential.

US: Real Gross Domestic Product Quarterly annualized rate, s.a.

s.a./ Seasonally adjusted. 1/ Mid-point of the central tendency interval of FOMC participants projections for the long-run change in real GDP. Sources: BEA , Federal Reserve and Blue Chip.

-4

-2

0

2

4

6

I 201

3

II 2

01

3

III 2

013

IV 2

01

3

I 201

4

II 2

01

4

III 2

014

IV 2

01

4

I 201

5

II 2

01

5

III 2

015

IV 2

01

5

Gross Domestic Product Potential GDP1/

Forecast


02

4

6

8

10

12

14

16

18

Co

rpo

rate

AA

A

Co

rpo

rate

BB

B

Co

rpo

rate

hig

h y

ield

*

AB

S

MB

S

Age

nci

es

Co

rpo

rate

AA

A

Co

rpo

rate

BB

B

Co

rpo

rate

hig

h y

ield

*

10-year range Current (7-Oct-14)

23% 27%

10 10

On the other hand, the expected increase in interest rates in the US will pose additional challenges for monetary policy in Mexico and other emerging market economies. Risks are enhanced by the continued search for yield

Volatility indexes for selected financial assets

Source: Banco de Mxico with data from Bloomberg 1/ MOVE (Merrill Option Volatility Estimate). 2/ VIX(CBOE Volatility Index). 3/ CVIX: 3-month implicit volatility of the most operated currencies. 4/ Actual volatility of the CRB index (index composed of 19 commodity futures contracts).

Yield to maturity of selected fixed income securities

Percent United States Europe

Source: Bank of America - Merrill Lynch. *Bonds with credit rating lower than BBB-.


Basis points Percent

0

10

20

30

40

50

60

70

80

90

S&P 500 2/ Currencyindex 3/

Commodityindex 4/

10-year range

0

50

100

150

200

250

300

Treasury notes 1/

Current (8-Oct-14)

11

and the fact that markets seem to be overly optimistic about the pace of interest rate adjustments in the US.

Federal Funds Rate Futures and FOMC Projections

%

Federal Funds Rate Implicit in the OIS1/ Curve and FOMC Projections

%

Source: FOMCs projections and own calculations with data from Bloomberg. 1/ Overnight Index Swap.

Source: Bloomberg and FOMC Economic Projections.


0.0

0.5

1.0

1.5

2.0

2.5

3.0

Jun

-12

Sep

-12

Dec

-12

Mar

-13

Jun

-13

Sep

-13

Dec

-13

Mar

-14

Jun

-14

Sep

-14

Dec

-14

Mar

-15

Jun

-15

Sep

-15

Dec

-15

Mar

-16

Jun

-16

Sep

-16

Dec

-16

FFR implicit in OIS curve

Median FOMC Mar-14 Median FOMC Dec-13

Median FOMC Jun-14

Median FOMC Sep-14

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Sep

-14

Dec

-14

Mar

-15

Jun

-15

Sep

-15

Dec

-15

Mar

-16

Jun

-16

Sep

-16

Dec

-16

11

FFR Futures 30-Jun-14

FFR Futures 08-Oct-14

Median FOMC Mar-14 Median FOMC Dec-13

Median FOMC Jun-14 Median FOMC Sep-14

12 Monetary Policy Implementation During US Policy Normalization

However, it is important to note that markets have differentiated across countries.

50

70

90

110

130

150

170

190

210

230

Jan

-13

Ap

r-1

3

Jul-

13

Oct

-13

Jan

-14

Ap

r-1

4

Jul-

14

Oct

-14

Oct

Mexico

Chile

Turkey

S. Africa

Peru

Brazil

Colombia

2014

Poland

1/ 5-year CDS. Source: Bloomberg, with data through 8 October 2014.

Emerging Markets: Credit Default Swaps 1/

Index 01-Jan-2013 = 100

Russia

Korea

13

Outline

Introduction 1

Beyond 2015 3

Monetary Policy in 2014-15 a. The External Environment

b. Domestic Conditions 2


14

Economic activity showed clear signs of recovery during the first half of 2014.

Real Gross Domestic Product Annual % and Quarterly Annualized Rate, s.a.

s.a./ Seasonally adjusted. Source: INEGI.


3.1

5.0

3.2

1.4

-4.7

5.2

3.9 4.0

1.4 1.8

4.2

-6

-4

-2

0

2

4

6

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

I-2

014

II-2

01

4

15

Exports were the main factor behind the expansion of economic activity, but a revival of domestic demand was also observed

Aggregate Supply and Demand Quarterly %, s.a.

s.a./ Seasonally adjusted. Source: Banco de Mxico and INEGI.

1.0

0.1

1.4

0.2

1.7

-1.2

3.9

-8

-6

-4

-2

0

2

4

6

GDP Imports PrivateConsumption

Govt.Consumption

PrivateInvestment

Govt.Investment

Exports

2014-I 2014-II


16

which has continued in more recent months.


Retail Sales Index 2003=100, s.a.

s.a. / Seasonally adjusted data. Source: Banco de Mxico with data from INEGI.

Imports of Consumption Goods 1/ and Domestic Sales of Light Vehicles Index 2007 = 100 and Thousands of

annualized units, s.a.

s.a. / Seasonally adjusted data. 1/ Excludes oil and automobile imports. Source: Banco de Mxico and AMIA (Mexican Association of the Automobile Industry).

110

114

118

122

126

130

20

08

20

09

20

10

20

11

20

12

20

13

20

14

Jul

Gross Fixed Investment Index 2008 = 100, s.a.

s.a./ Seasonally adjusted data. Source: INEGI.

85

90

95

100

105

110

20

08

20

09

20

10

20

11

20

12

20

13

20

14

Total

Construction

Jul

600

700

800

900

1,000

1,100

1,200

1,300

1,400

80

90

100

110

120

130

140

150

160

20

08

20

09

20

10

20

11

20

12

20

13

20

14

Imports of Consumption Goods

Domestic Sales of

Light Vehicles

Aug Sep

17 17

Nonetheless, substantial slack persists.


3

4

5

6

7

8

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

Urban

National

Aug

National and Urban Unemployment Rates

% of EAP, s.a.

EAP/ Economically Active Population. s.a./ Seasonally adjusted. Source: National Employment Survey (Encuesta Nacional de Ocupacin y Empleo), INEGI.

Output Gap

% of potential output, s.a.

s.a./ Calculated with seasonally adjusted data. Note: The shaded area is the 95% confidence interval of the output gap. Source: Calculated by Banco de Mxico with data from INEGI.

-14

-12

-10

-8

-6

-4

-2

0

2

4

6

8

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

GDP

IGAE

2Q-14 July

Consumer Price Index Annual %

Sources: Banco de Mxico and INEGI.

18 18

In the case of inflation, some upward pressures have been observed recently.


0

1

2

3

4

5

6

7

8

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

Headline

Core

Sep

19 19

However, they result from factors of a temporary nature, and are not demand-driven.

Core Inflation Annual %

Non-Core Inflation Annual %

Sources: Banco de Mxico and INEGI. Sources: Banco de Mxico and INEGI.


-5

0

5

10

15

20

20

09

20

10

20

11

20

12

20

13

20

14

Sep Non-core Livestock

-25

-20

-15

-10

-5

0

5

10

15

20

25

20

09

20

10

20

11

20

12

20

13

20

14

Sep Core Food, Beverage and Tobacco Air Transportation

20

Consequently, medium and long term inflation expectations remain well anchored.


End of 2014 End of 2015 Next 4 and 5-8 Years

Sources: Banco de Mxicos Survey, monthly. Last observation: September 2014. Banamex Survey, bi-weekly. Last observation: 7 October 2014.

Headline Inflation Expectations Median, %

2.5

3.0

3.5

4.0

4.5

Oct

-13

Dec

-13

Feb

-14

Ap

r-1

4

Jun

-14

Au

g-1

4

Sep Oct

2.5

3.0

3.5

4.0

4.5

Jan

-10

Au

g-1

0

Mar

-11

Oct

-11

May

-12

Dec

-12

Jul-

13

Feb

-14

Sep

-14

Sep

Next 5-8 Years

Next 4 Years

2.5

3.0

3.5

4.0

4.5

Jan

-13

Ap

r-1

3

Jul-

13

Oct

-13

Jan

-14

Ap

r-1

4

Jul-

14

Oct

-14

Sep Oct

Banco de Mxico

Banamex Banamex

Banco de Mxico

Oct

-14

21

Looking forward:

Strong external demand;

Expansionary monetary policy;

Fiscal stimulus; and

Increasing levels of confidence.

give support to Banco de Mxicos expectation of 2-2.8% GDP growth in 2014 and 3.2-4.2% in 2015, implying an expansion above potential in 2H-2014 and in 2015.


A negative although gradually closing output gap.

Gasoline price increases based on inflation expectations.

A favorable base effect after the tax reform.

22

A strong cyclical upturn during the rest of this year and the next is expected to coincide with the convergence of inflation to the 3% target in 2015 given:

1.

2.

3.


Uncertainty related to estimates of the output gap.

Faster closing of the output gap if the recovery of economic activity is stronger than currently foreseen.

Additional shocks deriving from the behavior of non-core inflation or other factors.

23

1.

2.

3.


This scenario is subject to a number of risks:

24

Monetary policy normalization in the US represents another risk for the Mexican economy.

Increased financial market volatility and uncertainty.

Tighter external financing.

Potential impact on peso exchange rate and inflation.

Risks have increased as the beginning of interest rate hikes draws closer.


25

Strong macroeconomic position:

Credible monetary and fiscal policies.

Flexible exchange rate regime.

Low current account deficit.

Record high international reserves.

FCL with the IMF.

Relatively low public debt.

Financial stability in the context of enhanced policy framework.

Favorable growth prospects after a major structural reform effort:

Labor markets: November 2012.

Education: September 2013.

Financial sector: January 2014.

Competition: May 2014.

Telecommunications: July 2014.

Energy: August 2014.


The Mexican economy has solid macroeconomic and financial stability bases to resiliently sail through the process.

26

Outline

Introduction 1

Beyond 2015 3

Monetary Policy in 2014-15 a. The External Environment b. Domestic Conditions

2


27

Inflation targeting has proved its merits in Mexico and other countries before, during and in the aftermath of the global financial crisis.

However, the crisis has highlighted a number of issues whose implications for inflation targeting regimes will have to be carefully assessed.

One of them is the need to better understand the role of monetary policy and other instruments in preserving financial stability.

Nonetheless, this does not imply a substantial modification of the fundamental structure of these regimes, nor does it raise question marks on their usefulness to anchor inflation expectations.


Beyond 2015

28 28

Beyond 2015, monetary policy is likely to operate in an environment characterized by world economic growth below that observed before the crisis...

GDP Growth Projections Annual %

Source: IMFs World Economic Outlook, October 2014.


-1

0

1

2

3

4

5

6

7

8

20

13

20

14

20

15

20

16

20

17

20

18

20

19

China

United States

United Kingdom

Japan Eurozone

29 29

and an upward trend in international interest rates, which underlines the importance of strengthening the domestic sources of growth.

Federal Funds Rate Annual %

Sources: FOMC, Bloomberg and Blue Chip.


0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

20

19

20

20

20

21

20

22

20

23

20

24

20

25

Federal Funds Rate FOMC OIS-implied Futures Blue Chip

30 30

Even before considering the key measures approved in 2014 (financial, competition, telecommunications and energy), Mexicos efforts of structural reform were deemed to be among the most ambitious in the world. Contrary to other experiences, this was not propelled by an economic crisis.

Economic Reform Responsiveness Share of OECD reform recommendations with

significant action taken during 2012-2013

Source: Own calculations based on results presented in OECD (2014), Going for Growth Interim Report, February.

0.57

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

CH

E

NO

R

TUR

CZE

USA

FRA

KO

R

AU

S

AU

T

BEL

CH

L

DEU

NLD

SWE

PO

L

FIN

JPN

SVK

CA

N

EST

LUX

SVN

NZL ITA

GR

C

HU

N

IRL

ISR

MEX

PR

T

DN

K

GB

R

ESP


Main challenges: adequate implementation of structural reforms, tackling other major structural obstacles to growth, continuous strengthening of economic fundamentals.

31 31

The latter should allow the economy to grow at faster rates without pressures on prices.


More flexible and competitive

product and input markets More efficient resource allocation More and better human and

physical capital More incentives for technological

change Stronger institutional framework

Productivity gains

Higher economic

growth

Lower inflationary pressures

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BANXICO - Monetary Policy Implementation During US Policy Normalization 10 de Octubre 2014.pdf

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