Another gift from Donald Trump to Mexico: a brewing case of stagflation

The peso sell-off is driving up Mexican prices.
The peso sell-off is driving up Mexican prices.
Image: Reuters/Carlos Jasso
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Mexico really just can’t catch a break—and it can blame a lot of that rotten luck on its northern neighbor. The latest on that list of American offenses is a bout of stagflation brewing in Mexico, according to Société Générale.

First, there’s the “inflation” part of the portmanteau. Donald Trump’s relentless Mexico-bashing throughout 2016 and the trade worries that inflamed, weakened the peso by around 20% last year.

The monstrous peso sell-off that’s resulted has whipped prices in Mexico steadily higher. Although it’s not scary-high yet—Mexico closed out the year with headline inflation of 3.4%, well within the target range of 2-4% set by Banxico, the central bank—inflation looks likely to worsen, says SocGen.

Investors are dumping pesos because if Trump sees through his vague threats to raise trade barriers, plummeting demand for Mexican exports—four fifths of which are bought by Americans—will sink the peso even more and drag the country into recession. The depreciating currency, in turn, heaps pressure on domestic prices. The tightening job market, sluggish growth in productivity, and a recent sharp hike in gas prices are exacerbating Mexico’s peso woes.

Then there’s the “stag” part. Usually, inflation is a headache for booming economies. What’s happening in Mexico these days is something closer to stagnation. On top of that, “dwindling confidence indicators and worsening financials point to the possibility of a faster-than-expected deceleration in growth,” writes SocGen’s Dev Ashish.

This puts Banxico in a tight spot. To stifle inflation, it will raise interest rates soon; Pantheon, a macroeconomic research firm, expects the bank to hike rates to 6.25% in the next month, up from the current 5.75%. They will likely climb to 7% by the end of 2017, says SocGen.

Higher borrowing costs will suffocate investment—which has already dropped dramatically in the last year—smothering growth even more. Et voilà, stagflation. And this nasty state in which prices keep climbing but growth keeps stagnating is notoriously hard to escape (see: US in the 1970s).

It’s possible that even if stagflation sets in, Mexico will still manage to slither free from its death-grip. A cheaper peso will boost exports, buoying the economy despite Mexico’s feeble productivity growth.

But the US—or, more precisely, the whims of the new White House—is still the big wild card here. If the US president-elect’s promised fiscal stimulus jump starts America’s economy, increased demand could jolt Mexican growth too, staving off a recession. However, as Trump’s erratic trade rhetoric continues to cloud Mexico’s trade outlook, the tumbling peso will force Banxico’s hand.

The real kicker here is, since 2005, Mexico has done a pretty bang-up job of taming inflation (with the exception of a spike in 2008 driven by higher commodity prices). In fact, since 2009, prices have been drifting steadily down, notes SocGen, adding that successful structural reforms—especially in telecoms—cooled inflation throughout 2015. But that clearly matters less than the steady blast of Trumpian bluster from the north.