- President Donald Trump has kept his promise to impose across-the-board 25% generalised tariffs on imports from Mexico and Canada. However, he granted a one-month exemption for goods included under the USMCA framework.
- In this note we explore the potential inflationary effect that the aforementioned tariffs could have on Mexico's inflation. To clarify, we anticipate four potential transmission mechanisms between tariffs and inflation: 1) an increase of imported good prices due to Mexico reciprocally hiking the current level of tariffs; 2) higher prices of some imports from the US due to an increase in production costs caused by tariff hikes there; 3) a USDMXN depreciation due to an escalation in trade tensions; or 4) a combination of the aforementioned effects.
- Our findings indicate that while the effects on inflation and its components are relatively low, a sufficiently strong and long-lasting shock could indeed accelerate inflation beyond 4.0% in 2025 and 2026 (ceteris paribus). We also conclude that the inflationary pressures would be more severe in 2026, as a sharp or enduring enough increase in tariffs could drive the economy into a recession, thereby offsetting contemporaneous inflationary pressures.
- It is important to note that this study only illustrates potential scenarios due to the imposition of tariffs. However, our year-end inflation forecasts remain unchanged, so far. We anticipate that headline inflation might stand at 3.5% YoY, while core inflation could reach 3.6% YoY in 2025e. Besides, our inflation forecasts for both headline and core inflation are at 3.5% YoY by YE2026e. Consequently, we anticipate that the monetary policy rate might end at 7.5% this year and at 6.5% in 2026e. However, with economic activity quickly decelerating (and even entering a recession in the upcoming quarters) and disinflation likely to continue, we maintain a downward bias in terms of the policy rate.
- The potential inflationary risks posed by tariffs would certainly favour our current overweight stance in terms of the Udibono curve and would change the tenor in which we are positioned. Were inflation to move to c.5%, the expected return of Udibonos would move to match that of MBonos at the belly and long end of the curve.
- If tariffs materialise and inflation turns out to be much higher, the short end of the curve would shift much more significantly. As such, in the event of a long-drawn-out tariff scenario, we would move to increase our exposure to Udibonos while switching our preference to the front- vs. long-end tenors.