Inflation in Mexico set to rise on higher fuel prices

Mexico's inflation is likely to be boosted higher as the government announced that it would be hiking fuel prices by nearly one-fifth from January. The government said that fuel price ceilings will be capped between 14.2% - 20% above December's prices.

The announcement has boosted economists' expectations on the 2017 inflation forecasts for Mexico which is likely to put pressure on the Mexican central bank which has been frequently hiking interest rates in an effort to curb inflation while battling the weaker exchange rate. The Mexican peso has been in a free fall since the U.S. presidential election campaigns with the declines seen accelerating since the November election results which saw the Republican candidate Donald Trump emerge victorious.

The Mexican central bank hiked interest rates for a fifth time in 2016 after inflation started to steady above the 3% inflation target rate from the central bank which has also increased on a weaker exchange rate. In the first half of December, Mexico's inflation accelerated to 3.34% rising at the fastest pace in nearly two years.

1 Mexico Inflation Nov2016

Mexico Inflation Rate: 3.315

Following the announcement on fuel price hikes, regional banks in Mexico have upgraded their forecasts for inflation in 2017. Banorte raised inflation outlook to 4.7%, up from 4.3% while Finamex, a brokerage firm expected a boost of nearly 0.8% to the consumer price index in January compared to a month ago. Finamex said that there are enormous challenges for the Mexican central bank's policies in 2017. The central bank hiked interest rates to 5.75% in 2016 which was the highest rate seen since April 2009.

The government's announcement was met with some resistance as various industry associations expressed concerns that higher fuel prices could add more headwinds to local businesses. The markets will also be looking at oil prices as the November OPEC decision to cut production comes into effect. Oil prices have been pushing higher ever since.

Mexico's Finance minister Jose Antonio Meade defended the decision to hike fuel prices noting that it was too expensive to keep fuel prices low while the international oil prices continue to steadily increase. "We couldn't keep doing it," Meade said on local television.

The president-elect, Donald Trump will be taking office on January 20th 2017. During his election campaign, Trump had repeatedly promised to build a wall at the U.S. – Mexican border while also promising to keep jobs within the United States. Even before taking office, Trump managed to coax, Carrier from moving jobs to Mexico. All of this is likely to keep pressure on the Mexican peso which has so far failed to react positively to the central bank’s rate hikes. Further rate hikes amid rising inflation is likely to see no positive results which could keep the central bank worrying over its policies and even more so on the prospects of stabilizing the exchange rate which is seen more and more vulnerable next year.

From a technical outlook, the USDMXN has closed the month of December with a spinning top pattern which comes at the top end of the rally. The strong gains since November 2014 have seen little to no pullback. This potentially increases the risk to the downside, especially if the dollar weakens below December's low of 20.139. The U.S. dollar’s strength is also a concern which has rallied so far on hopes of fiscal spending promises from Trump. Falling short of market expectations on fiscal spending plans could potentially see a strong rebalancing in the markets which could offer some short term respite for the Mexican peso. While this might be the catalyst for a correction in the Mexican peso, the long term prospects shows continued risks to the upside.

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