Inflation is above forecasts of a few months ago. The annual change in the CPI stood at 4.2% in November and is expected to close the year at 4.8%, to then fluctuate around 5% during the first half of 2025. This higher inflationary trajectory in the short term responds to a mix of cost factors. On the one hand, there is the global appreciation of the dollar —which has raised the exchange rate—, caused by increased uncertainty in the world. On the other hand, there is the rise in domestic labor costs. These shocks have occurred simultaneously, which has contributed to the narrowing of firms’ operating margins and leads to a pass-through to final prices higher than previously anticipated. In the medium term, cost pressures will tend to ease, and the evolution of inflation will be determined by the behavior of domestic demand, particularly by a lower performance of household consumption. This remained rather flat in the second and third quarters of the year, amid the low dynamism in job creation, the real depreciation of the peso and still pessimistic expectations. The convergence of inflation to the target will not be very different from what was previously estimated, with forecasts for activity that do not have major changes, but with consumption that will grow less than what was considered in September. The risk balance for inflation is biased upward in the short term, so caution is most needed. This means that the Board will steadily accumulate information regarding the progress of the economy in order to assess the timing for monetary policy report (MPR) cuts in the coming quarters.

As of November, the annual variation of total and core (non-volatile) CPI stood at 4.2% and 4.0%, respectively. These figures exceeded the forecasts in the last IPoM, especially in the core components of both goods and services (figure 1).

Recent inflationary dynamics have been influenced by the combined increase of several cost factors, among which the depreciation of the peso, higher labor costs and increases in electricity rates stand out (figure 2). Short-term inflation expectations have risen, while in the two-year term they remain around the 3% target.

The depreciation of the peso from the previous IPoM is mainly due to a global strengthening of the dollar, within a more uncertain external scenario. The sources of uncertainty have to do with ongoing war tensions, fears about the world’s fiscal and sovereign debt situation, and the impact of a possible reconfiguration of international trade, in a context of doubts regarding the policies that the new United States administration will adopt (figure 3).

For its part, the Federal Reserve began cutting its interest rate in September, mitigating a risk that had been significant until recently, although uncertainty persists as to the speed and point of arrival of this process. In this scenario, long-term interest rates remain high globally and it is estimated that this set of elements will continue to influence international financing conditions (figure 4).

Wage indicators have shown significant expansion rates, despite the weakness in the evolution of employment. The increase in wages is explained by a number of factors, such as the recovery of real wages after the high inflation of previous years and the readjustment of the minimum wage. Measured in real terms, the annual increase in the Labor Cost Index (INE) has outperformed its historical averages in recent months. In turn, indicators obtained from administrative records (AFC) show that the real annual change in wages has remained high over the last year, directly affecting some CPI items, which adds to the already mentioned cost pressures in the firms.

Although third-quarter activity was in line with forecasts in the September IPoM, domestic demand grew less than expected. By sectors, the favorable results of copper mining and industry stood out, in contrast to the poor performance of financial and entrepreneurial services, adding to the prolonged weakness of construction (figure 5).

Partial information for the fourth quarter, particularly the Imacec for October, shows a rise in activity. This result includes the impact of transitory supply elements in some sectors, factors whose recurrence has added a certain degree of volatility to the figures throughout the year. Meanwhile, the lower dynamism of spending is explained by weaker private consumption, which had as a counterpart higher public consumption. At the same time, the economy has received a greater boost from external demand, as reflected by the evolution of exports of goods and services (figure 6).

The lower growth in private consumption occurs in a context of weak job creation. Information from surveys and administrative data shows a decline or stagnation in several dimensions, such as formal employment (AFC), job creation in some sectors (INE) and also in less schooled groups (INE) (figure 7).

The slow pace of job creation would be associated with sluggish investment in non-mining industries over the last several quarters, the evolution of activity in the most job-demanding sectors (e.g., construction) and the rise in wage costs. The real wage bill has tended to moderate its recovery, thus affecting income disposable for consumption.

The performance of gross fixed capital formation (GFCF) has been in line with September projections and remains marked by dissimilar behavior between components and sectors. Machinery and equipment remains dynamic in the face of stagnant construction and works for several quarters now. By activities, dynamic mining investment again contrasts with other sectors lagging behind (figure 8).

Credit remains weak, evidencing a still limited demand for financing, in a context where short-term lending rates continue to reflect the MPR cuts. After their recent peaks, these have retreated about 550 and 750 basis points (bps) in the consumer and commercial portfolios, respectively (figure 9). Long-term interest rates (BTP10) were at levels close to 10bps lower at the statistical cut-off of this Report compared to September.

Projections

In the short term, the main adjustment to the central scenario of this IPoM is that it incorporates higher cost pressures. The projection also considers a greater pass-through of costs to prices in the coming months compared to previous estimates, given the simultaneity with which the various cost shocks have occurred and the firms’ squeezed operating margins. Core inflation leads the revisions, with average inflation in 2025 to be 0.5 percentage points higher than forecast in September. For headline inflation, that is partially offset by downward corrections in the external prices of some products, particularly fuels.

Into the medium term, inflationary pressures will be dominated by a weaker outlook for domestic demand (figure 10) and easing cost pressures, including the gradual reduction of the real exchange rate (RER). This, even though the reduction in the financial burden on individuals and in short-term interest rates will sustain the recovery of consumption in the foreseeable future.

In the central scenario, annual inflation will rise in the coming months, fluctuating around 5% during the first half of 2025. It will then begin to decline, ending the year at 3,6% and converging to the 3% target in the early months of 2026 (figure 11).

GFCF forecasts also decrease, while confirming differences across sectors (figure 12). The Capital Goods Corporation survey continues to foresee stronger mining investment in 2025 compared with other activities, a divergence that is also reported in the Business Perception Report and confirmed by high-frequency tax information sources. The main factor behind the adjustment of the projection is the tightening of external financial conditions —in the context of high global uncertainty— via greater persistence of long-term interest rates at high levels and a depreciation of the peso.

The GDP growth ranges forecast for 2025 and 2026 remain at 1.5%-2.5%. This factors in a higher public spending and a greater boost from the external sector, that are offset by the lesser stimulus foreseen for household and business demand. This also affects the estimate of 2.3% growth for this year, at the lower end of the range forecast in September (2.25-2.75%).

Compared to what was considered in September, the activity gap is now expected to be somewhat more negative until the end of 2025, which will contribute to mitigate inflationary pressures. Thereafter, the gap will return to its equilibrium as the economy continues to grow around its trend, demand recovers and the MPR cuts continue. The assessment regarding the level of the activity gap is consistent with an estimated narrow labor market gap (figure 13).

Projections include a real expansion of public spending that matches the one portrayed in the recently approved budget law. As a working assumption, the process of consolidating public finances is still expected to continue. All in all, the coming years present a challenging situation for complying with the fiscal rule.

Estimates for the current account deficit in the next two years are slightly reduced. This assumes a greater dynamism in exports of goods and services associated with the depreciation of the peso, including consumption derived from tourism and greater volumes shipped. Imports will also expand less, considering the evolution of domestic demand.

ERegarding the world economy, projections reiterate near 3% growth for trading partners for the 2025-2026 period. This estimate recognizes the increased likelihood of a more moderate slowdown than previously anticipated for the United States, whose recent data have surprised positively. Furthermore, the outlook continues to show slower growth in China over the next two years. In this context, the average copper price will approach values around US$4.3 throughout the projection horizon (figure 14).

Monetary policy

The short-term inflationary outlook has become more challenging due to increased cost pressures. These will lead inflation to fluctuate around 5% during the first half of 2025 according to the central scenario of this IPoM. All things considered, in the medium term, the weaker domestic demand would mitigate inflationary pressures. Thus, if the assumptions in the central scenario materialize, the MPR will follow a descending trajectory over the policy horizon.

The risk balance for inflation is biased upward in the short term, so caution is most needed. This means that the Board will steadily accumulate information regarding the progress of the economy in order to assess the timing for MPR cuts in the coming quarters.

In this IPoM, the sensitivity scenario that defines the upper bound of the MPR corridor is associated with a stronger impact from cost pressures. Should these intensify and/or the passthrough to final prices increase, higher inflation scenarios would be triggered, which in turn would increase both second-round effects and the possibility of observing greater persistence. Short-term risks in these scenarios are higher, considering the global uncertainty and the levels where inflation will stand in the central projection scenario. If such a scenario were to materialize, a more contractionary monetary policy strategy than the central scenario would be called for.

The lower bound is related to the effects of the higher uncertainty and weakness of the international scenario in the evolution of domestic spending. A sharper tightening of global financing conditions, associated with a worsening of the current sources of uncertainty, would further dampen agents’ spending, especially in investment. This could be compounded by a scenario in which employment deteriorates more than expected. This would lead to capacity gaps that would be discordant with the convergence of inflation to the 3% target, requiring more significant reductions of the MPR.

The risk scenarios are linked to global conditions, particularly financial ones, but with more severe consequences that could drive the MPR to movements outside the corridor. More extreme developments on the trade front, the ongoing war conflicts or the fiscal situation in several economies do not allow to rule out more complex episodes of risk aversion in financial markets. This could lead to a more pronounced exchange rate depreciation or a greater contraction of activity, considering that long rates have played a weaker buffering role in the face of negative shocks, particularly in the United States.