Inflation has fallen by more than 4 percentage points since its peak in August 2022. It is only 1.64 percentage points away from achieving the central bank’s 3 percent target. It seems simple, but what is missing is not so simple, because we need to control the most stable part of inflation, which is underlying inflation. When can the inflation target be achieved and how close are we to moving beyond this phase of accelerating price growth?
The answer must be looked for in the underlying part of inflation, that is, in the groups of goods and services whose prices are less volatile. Naturally, these prices change more slowly than the non-underlying part. The latter, which include agricultural products, energy and government-approved tariffs, are responsible for most of the decline in inflation so far.
Non-core inflation rose from 10.6 percent in August 2022 to 0.37 percent a year later, mainly due to a decline in energy prices, which recorded an annual decline of 5.99 percent from August 2023. This means that this part of inflation can no longer do much more to reduce inflation.
Core inflation, in turn, which explains around three quarters of general inflation, peaked in November 2022 (8.51 percent) and, as expected, has fallen more slowly than non-core inflation. It has fallen by 2.4 percentage points and is missing a further 3 percentage points to reach the target of 3 percent.
How difficult will it be to bring core inflation in line with the target? If we check the main components, we will notice uneven behavior. Virtually all of the decline in core inflation is attributable to goods, while services are experiencing virtually the same price fluctuations as last year. In fact, housing and education inflation in the services sector continues to rise. This shows us that not all prices are slowing their growth and what happens in the future depends in part on whether the rise in these prices is suppressed.
What can we expect now at the end of 2023? Private sector economists surveyed by the Banco de México expect underlying inflation to be 5.24 percent in December this year. A forecast that simply extrapolates the decline in core inflation over the last twelve months into the future implies that core inflation would end the year at around 4.5 percent. A significant difference from what was expected by professionals.
If this latter scenario occurs, general inflation could end the year below 4 percent. For their part, the specialists surveyed by the Central Bank expect general inflation of 4.66 percent for December this year. There are several factors that may explain why experts expect a slower decline in inflation than a forecast that extrapolates the past. These factors could include recent developments in service prices and the fact that the final stage of reducing inflation is usually more difficult.
Personally, I was surprised by the pace of decline in core inflation in recent months. Fortunately, the decline in inflation can continue to surprise us on the upside. Core inflation could end the year below 5 percent and general inflation below 4 percent. However, the final step to reduce inflation towards 3 percent could be the most difficult, so the Banco de México must be careful and not claim victory too soon.
