Photographer: Cesar Rodriguez/Bloomberg

The Worst of Mexico's Inflation and Growth Struggles May Be Over

  • Annual inflation rate fell in early July by most since January
  • IMF growth forecast, S&P’s better outlook add to positive news

After months of investor concern that slammed everything from Mexico’s currency to its inflation outlook, the nation’s economy is riding a good streak.

A report on Monday showed the annual inflation rate fell in early July by the most since January, suggesting that the pace of consumer price increases may finally be stabilizing after a year of acceleration. Another key indicator published the same day showed growth was more than analysts expected in May, and the International Monetary Fund increased the nation’s 2017 growth forecast days after Christine Lagarde’s top deputy praised the economy’s resilience.

Add to all this last Tuesday’s improved credit outlook from S&P Global Ratings, and things are suddenly looking a good bit better for Latin America’s second-largest economy. This is the kind of good news that was presaged by investors who bet on the peso, turning the currency into the world’s best performer of 2017 after starting the year with a plunge to a record low as Donald Trump prepared to take office and threatened to tear up the North American Free Trade Agreement.

"We see early signs that inflation is peaking," said Alberto Ramos, chief Latin America economist at Goldman Sachs Group Inc. "The noise around trade and the bilateral relationship with the U.S. has died down significantly."

The jump in inflation expectations earlier this year amid a gasoline price increase and the peso’s tumble led Banco de Mexico to buck peers including Brazil and Russia and raise the key rate in seven straight decisions to 7 percent, the highest level since 2009. Policy makers signaled last month that the tightening cycle is over.

The peso has surged 22 percent to levels stronger than 18 per dollar since Trump took office on Jan. 20, driven by diminishing expectations for the end of Nafta or an overhaul that would damage Mexico’s economy. The U.S., Mexico and Canada are set to begin talks to update the trade agreement next month, and in recent months Trump administration officials have signaled that an eventual deal could benefit all three nations.

As a result, Mexico is being rewarded in the bond market. The nation’s five-year credit-default swaps fell on Thursday to the lowest level since March 2015, showing improving investor confidence in the nation’s financial outlook.

Still, the Mexican economy isn’t out of the woods yet. The Nafta talks could still bring unexpected bad news or peso volatility. The inflation rate, while declining in early July, didn’t come down as much as economists forecast, and it may still fluctuate to as high as near 6.5 percent in August before slowing by year end, Goldman Sachs’ Ramos said.

All in all, the outlook has improved significantly since the start of the year, when it seemed possible Mexico could lose control of its currency, leading to capital outflows.

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