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THE LATIN AMERICA ECONOMIC MONITOR SEPTEMBER 24, 2014ANDRES ABADIA,SENIOR ECONOMIST

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board believes that growth is not exerting upward pressure on consumer prices due to the slack in the economy, which will be reduced only gradually.

Banxicos board also believes that the interpretation and forecasting of the U.S. Feds monetary policy has become more complicated, but expects the start of the hiking cycle in 2015. Policymakers think the Fed has given mixed signals and consider, additionally, that it will be difficult for the U.S.s central bank accurately to identify the level of slack in the labor market, taking into account both cyclical and structural factors. It seems reasonable to think, therefore, that Banxico will now focus more on domestic economic issues in its policy discussions, rather than the withdrawal of monetary stimulus in the U.S. in 2015.

For this reason it is important, in our view, to pay close attention to measures of inflation over the coming months. The annual headline CPI inflation rate rose to 4.1% in August from 4.0% in July, the highest level since February. The recent upward trend in inflation rates is due to short-term pressures, especially in food prices, which will continue to be felt over the coming months. We expect inflation to remain at around 4% through the end of this year and then to head towards Banxicos target of 3%. Under

The minutes of Banxicos latest monetary policy meeting on September 5, when Mexicos central bank held rates at record-low 3%, revealed that the decision was unanimous; the balance of risks has improved. The board believes that domestic demand is gaining strength and expects the recovery will continue over the coming quarters.

As a reminder, Mexicos economy grew 1.0% quarter-over-quarter in Q2, after 0.4% in Q1, propelled mainly by the strength of the external sector, and a slight improvement in domestic demand. These figures are a clear indication that the economy is in recovery mode from its weakest growth period for four years, and we expect the expansion to continue. At the same time, according to the minutes, the


Mexican Rates on Hold; Inflation Will Drop Sharply Next Year

Mexico set to keep rates on hold despite elevated inflation; temporary adverse factors will fade.

No pressure from the labor market; unemployment is set to drop but Banxico sees spare capacity.

Retail sales are gathering upward momentum as credit conditions ease and confidence improves.

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Mexico CPI, y/y%

Upper end of Banxico's Inflation Target

Mexico Core CPI, y/y%

BUT PRICES WILL BE CONTAINED, SO NO RUSH TO HIKE RATES

-10 -8 -6 -4 -2 0 2 4 6 8

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Mexico GDP, y/y% (Right) Mexico private consumption, y/y% (Right) OECD leading indicator, advanced one quarter (Left)

BANXICO IS OPTIMISTIC ON ACTIVITY


these circumstances we do not expect a rate increase over the coming quarters.

The convergence towards Banxicos inflation target in 2015 reflects lower gasoline prices as the government changes its pricing formula, subdued telecom prices due to new regulations, and a favorable basis effect due to the January anniversary of this years tax increase. This alone will reduce the headline inflation rate by 0.5%. Policymakers also believe that core inflation rate will run below the target center next year. In short, then, we think if inflation stays close to 3%, in line with our central scenario over the first half of 2015, monetary policy will be on hold for some time.

The labor market data published on Monday also underpin the prospect of tame inflation over the coming months. The unemployment rate fell to 4.9% in August, seasonally adjusted, from 5.2% in July. But it is still high by historic standards, indicating that the labor market will not be a source of inflation pressures over the coming months.

Our short-term view of Mexicos labor market is positive. It will improve moderately over the next few months, with the unemployment rate heading near to 4.5%, seasonally adjusted. The improving labor market is boosting sentiment: Consumers were slightly more optimistic about their own economic circumstances last month, and their expectations also improved. At the same time, the government recently adopted additional measuressuch as the announcement of a major new Mexico City airport to

quadruple capacityto stimulate the economy. This, together with the improvement in the U.S. economy, will translate into better labor figures in months to come. The level that we expect for the jobless rate is still above pre-crisis levels and sufficiently high to prevent inflationary pressures.

Yesterdays retail sales report was also encouraging. Retail sales increased 2.0% year-over-year in July, from 1.1% in June, boosted by a 15% month-to-month jump in auto sales, thanks in part to easier financing conditions. The latest car sales data, for August, show a further 8% month-to-month increase, indicating that the positive trend is solid. The surge in sales is being driven by an improving labor market, especially in the manufacturing sector, and better consumer confidence, in line with a gradual recovery of economic activity. These data point toward stronger domestic demand in Q3. Looking ahead, we expect the positive trend to persist in coming months.

Finally, today keep an eye on the economic activity index in Mexico to see additional evidence of the gradual improvement of the economy, especially in the industrial sector. In Brazil, the current account needs to be watched as the economy is still struggling to get out of contraction. And in Argentina, look for the Q2 GDP data to confirm that the country stayed in recession, hurt by the collapse of consumer spending and industrial output.

THE LATIN AMERICA ECONOMIC MONITOR SEPTEMBER 24, 2014 WWW.PANTHEONMACRO.COM

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Mexico Unemployment Rate Three-month average

THE MEXICAN LABOR MARKET IS STARTING TO IMPROVE

Andres Abadia +1 914 610 3830

[email protected]

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Retail sales, y/y%, three-month average ANTAD sales, y/y%, three-month average

MEXICAN RETAIL SALES ON THE PATH TO RECOVERY?


THE LATIN AMERICA ECONOMIC MONITOR

THIS WEEK IN BRIEF

Note: D prefix denotes Datanotes for these releases.

SEPTEMBER 24, 2014 WWW.PANTHEONMACRO.COM

Monday, September 22 D: Mexico unemployment rate (8)/8:00 LocalThe unemployment rate fell to 4.9% in August, from5.2% in July, pointing to a positive labor market in Q3.

Tuesday, September 23 D: Mexico retail sales (7)/8:00 LocalMexico retail saes rose 0.4% in July month-to-month, lifting the year-over-year rate to 2.0% from 1.1%, and pointing to improving consumer demand in Q3. Argentina trade balance (8)/17:00 LocalReleased post-press. We expect a trade surplus of $780M, lower than July due to the decline in exports of commodities and manufactured goods. Consensus: $826M.

Wednesday, September 24 D: Mexico economic activity IGAE (7)/8:00 LocalThe activity index is likely to reverse last months solid increase, falling to 2.4% from 2.7%, but it will stay above its long term trend, thanks to the improvement of the industrial and service sectors. Consensus: 2.1%. Mexico biweekly CPI (H1/8)/8:00 LocalWe expect the biweekly CPI to rise 0.18%, keeping the annual headline close to 4.1%. Consensus: 0.15%. D: Brazil current account balance (8)/11:30 LocalBetter trade figures should cushion the current account deficit, staying close to -$5000M. Consensus: -$5350M. Argentina GDP (Q2)/17:00 LocalHigh inflation, the collapse in tradedue to USD shortagesand Brazils low growth, will take a toll on Q2 activity data. We expect a -0.3%. Consensus: -0.4%.

Thursday, September 25 D: Brazil unemployment (May-to-Aug)/10:00 LocalWe think unemployment increased moderately between May and August due to weakness in economic activity so far this year. The rate should rise to 5% in August from 4.8% in May. The statistical office postponed the publication of the full report since May due to a strike. Consensus: 4.9%.

Friday, September 26 D: Brazil PPI manufacturing (8)/10:00 LocalPrices should ease further, falling for the sixth consecutive month. We expect a 0.2% dip. Consensus: N/A. D: Mexico trade balance (8)/8:00 LocalIncreasing auto shipments should continue boosting exports, but not enough to compensate for capital goods imports. We expect a -850M deficit. Consensus: -667.5M. Argentina economic activity index (7)/17:00 LocalLow confidence and import restrictions will continue to hurt growth, we expect a -0.4% drop. Consensus: -0.3%. Colombia overnight lending rate (8)/12:00 LocalMinutes of the last meeting took a more neutral stance, suggesting that the end of the tightening cycle is close. Consensus: 4.5%.

PANTHEON LATAM FINANCIAL CONDITIONS DASHBOARD

Currency Market

Value Week, % YTD, % Value Week, % YTD, %Argentina 8.4 -0.2 -22.5 11,536 5.2 114.0Brazil 2.4 -2.8 0.1 58,374 0.1 13.3Chile 597.2 -1.3 -12.0 4,028 -0.9 8.9 Colombia 1,970 0.6 -2.1 14,224 -0.1 9.0 Mexico 13.2 0.3 -1.3 46,168 0.6 8.1 Peru 2.9 -0.2 -2.3 16,908 -1.0 7.3Venezuela 6,292 -- -- 2,777 2.3 1.5

Real GDP Inflation Interest rate

2013 2014 2013 2014 2013 2014Argentina 3.0 -1.0 27.0 25.0 -- --Brazil 2.5 0.6 5.9 6.1 10.0 11.00Chile 4.2 2.5 2.9 3.9 4.5 3.00 Colombia 4.7 5.1 1.9 3.0 3.25 4.50 Mexico 1.1 2.5 3.9 3.9 3.5 3.00 Peru 5.8 4.5 2.9 3.1 4.0 3.25Venezuela 1.4 -2.5 56.2 64.0 15.5 --

PANTHEONS ECONOMIC FORECAST

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Coee

Soybean

Crude WTI

Copper

COMMODITY PRICES, (PRICE INDEX, 01/01/2013=100)

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EMBI LatAm Brazil Mexico

INDEX EMBI SPREAD LATAM HISTORY (01/01/2013=100)



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