GDP Growthforecasts Advanced and 2013 Performance Annual Continued July

Quarterly Report April – June 2018 August 29th, 2018 Outline

1 External Conditions

2 Evolution of the Mexican Economy

3 Inflation

5 Forecasts and Final Remarks

Quarterly Report April - June 2018 1 2019 The Source world 2010 . However, : IMF,

WEO 2011 economy October October 2017 July 2018 2012 the 2017 GDP GDP GrowthForecasts Advanced and 2013 performance Annual continued July

2018 2014 . Emerging % change

2015 World to

2016 of grow the 2017 main and 2018 Forecasts advanced it Quarterly Report April

2019 is anticipated 0 1 2 3 4 5 6 7 8 economies - June 2018 Source to

: 2018 IMF, U.S. continue WEO has 2018 and 2019GDP GrowthForecasts

October 2019 become 2017 Eurozone

2018 expanding Selected Economies: , April Annual Annual change% and 2019 more July 2018 diverse .

2018 for Japan the

2019 July 2018 April 2018 October 2017 . rest UnitedKingdom 2018 of 2018 2019 2 0.0 0.5 1.0 1.5 2.0 2.5 3.0 and Although slack in advanced economies continued to decrease, there are differences in the growth rate of wages. Advanced Economies Output Gap Unemployment Gap Wage Indicators % of potential GDP Percentage points Annual % change, s. a. 6 5 4 Forecasts U.S. Eurozone 4 4 3 U.S. United Kingdom United Kingdom 3 2 2 Eurozone U.S. 2 Eurozone 0 1 1 -2 0 0 Japan United Kingdom -4 -1 -1 Japan Japan -6 -2 -2 May June June July July

-8 -3 -3

2008 2010 2012 2014 2016 2018 2012 2014 2016 2018

2008 2010 2012 2014 2016 2018 Source: IMF, WEO April 2018. Source: Prepared by Banco de México with data from CBO, OECD, Economic Outlook, s. a. / Seasonally adjusted figures. November 2017 and National Statistical Offices. Note: Wage indicators for the U.S., Eurozone, United Kingdom, and Japan correspond to average hourly earnings, negotiated wages, average weekly earnings, and average monetary compensation, respectively. Source: Prepared by Banco de México with data from CBO, OCDE, Economic Outlook, November 2017 and National Statistical Offices; BLS, BCE, Bloomberg and ONS.

Quarterly Report April - June 2018 3 Likewise, inflation continued to increase gradually in the main advanced economies, although differences across the countries became more pronounced as well. Advanced Economies: Inflation Annual % change Headline Core 4 4

United Kingdom United Kingdom 3 3

U.S. 1/ 2 2 U.S. 2/ Eurozone 1

1 Eurozone Japan 0 Japan 0 -1

June June July July

-1 -2

2013 2014 2015 2016 2017 2018 2013 2014 2015 2016 2017 2018 1/ U.S. figures correspond to the implicit price deflator for personal consumption expenditures. 2/ U.S. figures correspond to the implicit price deflator for personal consumption expenditures. Japan figures exclude fresh Source: Haver Analytics and International Monetary Fund. food and energy, as well as the effect of the higher consumption tax. Source: Haver Analytics and International Monetary Fund. Quarterly Report April - June 2018 4 In the context described, there was a greater divergence between the pace at which the main central banks have adjusted their monetary stance, as well as the pace at which they are expected to continue approaching a more neutral stance. In particular, the Federal Reserve is expected to continue normalizing its stance at a faster pace than other advanced economies’ central banks. Expected Monetary Policy Rates Implicit in OIS Curve 1/ Prospective Distribution of the Reference Rate at the end % of 2019 Implicit in Options 3/

Mode Density End of End of 3.00 United States Implied target rate in OIS Mar 30, 2018: 2.46% 1.875% 2018 2019 curve August 28th, 2018 Jun 18, 2018: 2.80% (Aug-18) 2.50 Aug 28, 2018: 2.85%

2.00 -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5%

2/ Mode Federal Reserve Mar 30, 2018: 2.07% Canada 1.50 1.50% Jun 18, 2018: 2.14% (Aug-18) Aug 28, 2018: 2.28% 1.00 -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% Bank of England Mode 0.50 Mar 30, 2018: 0.96% Jun 18, 2018: 0.93% United Kingdom Aug 28, 2018: 1.10% 0.75% 0.00 (Aug-18) Bank of Japan -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% -0.50 Mode Eurozone European Central Bank Mar 30, 2018: -0.18% 0.00% -1.00 Jun 18, 2018: -0.23% (Aug-18)

Aug 28, 2018: -0.28%

Jun-15 Jun-16 Jun-17 Jun-18 Jun-19

Dec-15 Dec-16 Dec-17 Dec-18 Dec-19 Dec-14 -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 1/ OIS: Fixed-For-Floating swap where the fixed interest rate is the reference rate. 2/ Data for the observed federal funds rate corresponds to the average between the lower and upper bounds of the range (1.75% - 2.00%). 3/ The implicit distribution of the reference rate is obtained by the changes in interest rates implicit in options over the 3-month rates futures (LIBOR in the U.S. and United Kingdom, EURIBOR in the Eurozone and bankers acceptance in Canada). It is assumed that the spread between the reference rate and the 3-month rate is maintained constant. The implicit distribution in options uses the Breeden-Litzenberger method. Source: Bloomberg. Quarterly Report April - June 2018 5 Thus, interest rates in the U.S. increased and the U.S. dollar showed a generalized strengthening.

Advanced Economies: Government United States: Dollar Index (DXY) 1/ Bonds Interest Rates Index % 10-Year 2-Year 3.5 3.5 106 U.S. Appreciation 3.0 3.0 103 2.5 2.5 100 2.0 2.0 United Kingdom U.S. 1.5 1.5 97

1.0 1.0 94 Eurozone United Kingdom 0.5 0.5 Japan 91 0.0 0.0 Japan Eurozone 88 -0.5 -0.5

August August August

-1.0 -1.0 85

Jul-16 Jul-17 Jul-18

Jan-16 Jan-17 Jan-18

Sep-16 Sep-17

Jan-16 Jan-17 Jan-18

Nov-16 Nov-17

Mar-16 Mar-17 Mar-18

Sep-16 Sep-17

Mar-16 Mar-17 Mar-18

May-16 May-17 May-18

Nov-16 Nov-17

Mar-16 Mar-17 Mar-18

May-16 May-17 May-18 Source: Bloomberg. Source: Bloomberg. 1/ The U.S. dollar index corresponds to the weighted average of the value of the dollar relative to a basket of six currencies: EUR: 57.6%, JPY: 13.6%, GBP: 11.9%, CAD: 9.1%, SEK: 4.2%, y CHF: 3.6%. Source: Bloomberg.

Quarterly Report April - June 2018 6 International financial markets registered bouts of volatility, related, in part, to greater trade tensions, the risk of a tightening of monetary conditions and certain geopolitical factors. U.S. stock indices continue showing gains, which is in part attributed to tax reductions. In this context, there were few changes in the asset prices of other advanced economies. VIX 1/ Advanced Economies: Stock Markets Index Index 01-Jan-2016=100 40 150

35 140 S&P 500 30 130 FTSE 25 120 Nikkei 20 110

15 100 Europe 600

10 90

August August

5 80

Jul-16 Jul-17 Jul-18

Jan-16 Jan-17 Jan-18

Oct-16 Oct-17

Apr-16 Apr-17 Apr-18

Oct-16 Oct-17

Apr-16 Apr-17 Apr-18

1/ The VIX Index is a weighted implied volatility indicator for the S&P 500. Source: Bloomberg Source: Bloomberg.

Quarterly Report April - June 2018 7 Capital inflows to emerging economies continued to decline, and financial asset prices had a predominantly negative performance. Emerging Economies Accumulated Capital Flows Nominal Exchange Rate against USD Market Indicators that Measure the (Debt and Equity) 1/ Index 01-Jan-2017 = 100 Domestic Sovereign Credit Risk 2/ Basis points Billions of dollars 170 200 550 Depreciation 150 500 130 180 2017 450 110 Turkey 2012 400 90 160 2018 2009 350 70 August 22th Turkey 50 300 2016 140 30 250 Brazil Colombia 10 200 120 -10 Chile Brazil 2013 Colombia 150 -30 Mexico 100 100 2008 -50 Mexico 50 -70 August Korea Chile August 2015 Korea

-90 80 0

1 4 7

10 13 16 19 22 25 28 31 34 37 40 43 46 49 52

Jul-17 Jul-18

Jan-17 Jan-18 Jan-18

Weeks Jan-17

Sep-17

Nov-17

Mar-17 Mar-18

Nov-17

Mar-17 Mar-18

May-17 May-18

1/ The sample covers funds used for the buying-selling of stocks and bonds from Source: Bloomberg. 2/ This refers to 5-y ear Credit Default Swaps. emerging countries, recorded in advanced countries. Flows exclude portfolio Source: Bloomberg. performance and changes in the exchange rate. Source: Emerging Portfolio Fund Research. Quarterly Report April - June 2018 8 Risks to World Economic Outlook  Risks to the world economy have increased both in the short and in the medium term.  There are significant risks to the global outlook:  A change in the economic and trade integration model.  A greater-than-anticipated slowdown of the Chinese economy.  There are other risks that could lead to tighter global financial conditions, which could further limit the sources of financing for emerging economies:  In the U.S., a greater-than-estimated increase of inflation could lead to a faster adjustment of the monetary policy than currently expected.  A further deterioration of macroeconomic conditions in certain emerging economies, in particular those with high indebtedness levels, either public or private, and macroeconomic imbalances.  An escalation of geopolitical conflicts.  Finally, one of the main risks is that, having a complacent attitude or taking actions that undermine the fundamentals of their economies, the authorities of the main economies fail to carry out the actions necessary to promote sustained growth and to guarantee the stability of international financial markets.

Quarterly Report April - June 2018 9 Outline

1 External Conditions

2 Evolution of the Mexican Economy

3 Inflation

4 Monetary Policy

5 Forecasts and Final Remarks

Quarterly Report April - June 2018 10 observed In Source s . a .

/ 0.6 2012 Q Seasonally : 0.9 Source 0.6 2

0.8 2018 :

Mexico’s 2013 0.3 adjusted Quarterly Quarterly % -0.7 GrossDomestic Product

1.0 over

0.5 , National data

2014 0.6 economic 1.3 . 0.4 the

Accounts 1.1 2015 0.5

1.1 change, s. a. 1.3 previous System -0.1 2016 0.6 activity

(SCNM), 0.5 1.2 1.0 0.3 INEGI

2017 Q2 2018

0.5 two -0.10.0 .

0.8 contracted 2018 1.0 -0.2 quarters -1 0 1 2 100 105 110 115 120 90 95 . Source s with Global Global IndicatorEconomic of Activity .

a 2012 . / Seasonally : Mexico’s Industrial Quarterly Report April

2013 respect Index s. a. 2013=100, adjusted National 2014 Total Agricultural data Accounts to . 2015 Services System Q -

June2018 2016 1 (SCNM), 2018 2017 INEGI June , . 2018 which 80 90 100 110 120 130 140 stands System Source s Electricity, Water and Gas . 2012 a . / Seasonally : (SCNM), Monthly

2013 in INEGI adjusted contrast Industrial Index s. a 2013=100, .

2014 Industrial Activity data Activity . 2015 Mining Indicator, with

2016 Manufactures Construction Mexico’s the

2017 . National recovery June 11

Accounts 2018 70 75 80 85 90 95 100 105 110 115 120 In particular, investment lost momentum as compared to the incipient recovery displayed at the end of 2017 and in early 2018.

Investment and its Components Investment in Residential and Real Value of Construction Output by Index 2013=100, s. a. Non-residential Construction Contracting Institutional Sector 1/ Index 2013=100, s. a. Index Jan-2012=100, s. a. 140 125 200

135 Residential 120 Domestic Machinery 175 130 Private Excluding and Equipment 115 125 Housing 150 Imported Machinery 110 120 and Equipment Private 115 105 125 Total 110 100 Total 100 105 95 100 Non-residential 75 Construction 90 Public 95 Private Housing May May June

90 85 50

2012 2013 2014 2015 2016 2017 2018 2012 2013 2014 2015 2016 2017 2018

2012 2013 2014 2015 2016 2017 2018 s. a. / Seasonally adjusted data. s. a. / Seasonally adjusted data. s. a. / Seasonally adjusted data. Source: Mexico’s National Accounts System (SCNM), INEGI. Source: Mexico’s National Accounts System (SCNM), INEGI. 1/ Seasonally adjusted by Banco de México, except for the total. Source: Prepared by Banco de México with data from ENEC, INEGI.

Quarterly Report April - June 2018 12 In contrast, private consumption maintained a positive trend, supported by the performance of the real wage bill and of workers’ remittances.

Monthly Indicator of Private Consumption Workers’ Remittances Consumer Confidence Index and its Components USD and constant pesos billions, s. a and Total Real Wage Bill Index 2013=100, s. a. Index 2013 =100, s. a. 130 3.1 48.4 115 Real Wage 125 110 2.9 44.6 Bill Domestic Services Mexican Pesos 1/ 120 2.7 105 Imported Goods 40.8 100 115 2.5 37.0 95 110 2.3 Total 33.2 Consumer 90 105 2.1 Confidence 85 29.4 Index 100 1.9 80 Domestic Goods 25.6 95 1.7 75 21.8 90 1.5 70 U.S. Dollars Q2 2018 May June July

85 1.3 18.0 65

2012 2013 2014 2015 2016 2017 2018

2012 2013 2014 2015 2016 2017 2018 s. a. / Seasonally adjusted data. s. a. / Seasonally adjusted data. s. a. / Seasonally adjusted data. Source: Mexico’s National Accounts System (SCNM), INEGI. 1/ Prices as of the second fortnight of December 2010. Source: Prepared by Banco de México with data from the National Source: Banco de México and INEGI. Employment Survey (ENOE), INEGI and National Consumer Confidence Survey (ENCO), INEGI and Banco de México. Quarterly Report April - June 2018 13 In turn, manufacturing exports showed a degree of weakness. The medium-term trend of the external accounts has reverted, there is a surplus in the non-oil trade balance and a deficit in the oil trade balance.

Manufacturing Exports Trade Balance Current Account Index 2013 = 100, s. a. USD millions % of GDP 160 8,000 1.0

150 6,000 Current Account Automotive Non-oil 0.0 4,000 140

2,000 -1.0 130 Total 0 120 -2.0 -2,000 110 -4,000 -3.0 Total Moving 100 Oil -6,000 Average Rest (4 Quarters) -4.0 90 -8,000

July Q2 2018 Q2 2018

80 -10,000 -5.0

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

2012 2013 2014 2015 2016 2017 2018

s. a. / Seasonally adjusted data. Source: SAT, SE, Banco de México, INEGI. Merchandise Trade Balance. Note: Blue bars with a darker tone refer to the first quarter of each year. Source: Banco de México with data from SAT, SE, Banco de México, INEGI. SNIEG. Information of National Interest. Source: Banco de México. Merchandise Trade Balance. SNIEG. Information of National Interest. Quarterly Report April - June 2018 14 Thus, it is estimated that in Q2 2018 slack conditions presented a greater-than-anticipated easing, mainly as a reflection of the contraction of economic activity in this time frame. As a result, the output gap estimates were positioned at levels close to zero.

Output Gap 1/ Monthly Slack Index 3/ % of potential output, s. a. % 23 8 6

21 6 20 GDP Excluding the 4

19 Oil Sector 2/ 4 18

17 2

16 2

15 0 14 GDP 13 -2 0

11 -4 10 -2 9 -6

7 -8

6 -4

5 -10

4 Q2 2018 May

3 -12 -6

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 s. a. / Estimated with seasonally adjusted data. 3/ Index constructed based on the Model Confidence Set (MCS) methodology; see Banco de México Inflation Report, 1/ Estimated using the Hodrick-Prescott (HP) filter with tail correction; see Banco de México Inflation Report, April- June 2009, p.69. October – December 2017. Monthly slack index is based on the first principal component of a set that includes 11 indicators. 2/ It excludes oil and gas extraction, services related to mining and the manufacture of oil and coal products. The first component represents 51% of joint variation of the monthly indicator. Gray lines correspond to individual slack Note: Confidence interval of the output gap calculated with an unobserved components method. The dotted line refers to the indicators used in the analysis of Principal Components. confidence interval for the gap calculated without the oil sector while the blue area is the interval corresponding to the total GDP. Source: Own elaboration with data from INEGI and Banco de México. Source: Estimated by Banco de México with data from INEGI and Banco de México. Quarterly Report April - June 2018 15 In turn, slack conditions in the labor market remained tight. Labor Market Gap 1/ Average Wage of Salaried Workers according Percentage points, s. a. to the National Employment Survey (ENOE) 2/ Unemployment Rate Unemployment Rate and Annual % change Informal Salaried Workers 2.5 4 7 June June Q2 2018 2.0 6 3 5 1.5 Nominal 2 4 1.0 3 1 0.5 2

0.0 1 0

-0.5 0 -1 -1 -1.0 Real -2 -1.5 -2 -3

-2.0 -3 -4

2003 2005 2007 2009 2011 2013 2015 2017

2018

2012 2013 2014 2015 2016 2017 2018

2003 2005 2007 2009 2011 2013 2015 2017 2018 s. a./ Seasonally adjusted data. 2/ To calculate average nominal wages, the bottom 1 percent and the top 1 percent 1/ Shadows represent confidence bands. The interval corresponds to two average standard deviations among all estimates. in the wage distribution were excluded. Individuals with zero reported income or Source: Banco de México with data from INEGI (ENOE). those who did not report it are excluded. Source: Calculated by Banco de México with data from INEGI (ENOE).

Quarterly Report April - June 2018 16 Since 2015, the Mexican economy has observed a strong decrease in the financing from external sources, which has been partially offset by an increase of domestic sources and a lower absorption by the public sector resources. Sources and Uses of Financial Resources Financing to the Non-financial Private Sector Annual flows as % of GDP Real annual % change 5/ 2013 2014 2015 2016 2017 Q2-2018 Total 15 12 Total sources 10.0 9.7 5.8 7.4 7.9 7.2 External Domestic 6/ Domestic sources 1/ 5.7 5.6 4.6 5.5 6.5 5.9 9 6 External sources 2/ 4.2 4.1 1.2 1.9 1.3 1.3 Total 3 Total uses 10.0 9.7 5.8 7.4 7.9 7.2 0 International reserves 1.0 1.3 -1.5 0.0 -0.4 -0.1 -3 Public sector financing 4.1 4.7 4.1 2.9 1.1 2.8 -6 Q2 2018 Private sector financing 3/ 4.1 2.5 3.0 3.2 3.9 3.7 -9

Domestic 2.5 1.7 3.0 3.3 3.3 3.2

Sep-13 Sep-14 Sep-15 Sep-16 Sep-17

Mar-14 Mar-15 Mar-16 Mar-17 Mar-18 External 1.7 0.8 0.1 0.0 0.6 0.5 Mar-13 4/ Domestic 6/ Other concepts 0.8 1.2 0.1 1.3 3.2 0.8 20 Current Account Deficit 2.4 1.8 2.5 2.1 1.6 1.3 15 Note: Figures expressed in percent of the nominal average annual GDP. 1/ Corresponds to the domestic financial assets aggregate F1, which includes the monetary aggregate M3 plus other instruments held by resident Consumption sectors that hold money that are not considered in the monetary aggregates. 2/ Includes the monetary instruments held by non-residents (equivalent to the difference between M4 and M3) and other non-monetary external 5/ 10 sources (the external debt of the Federal Government, the external debt of public agencies and companies, the external liabilities of commercial Firms banks, external financing to the non-financial private sector, the raising of agencies, among others). 3/ Includes the financial intermediaries credit, of the National Housing Fund (Infonavit) and Fovissste, the issuance of domestic debt and external 5 financing of firms. 4/ It includes capital accounts, and results and other assets and liabilities of commercial and development banks, non-bank financial intermediaries, Housing of the National Housing Fund (Infonavit) and Banco de México –including the securities issued by this Central Institute for the purposes of monetary June regulation, especially those related to neutralizing the monetary impact by the operational surplus–. Similarly, it includes non-monetary liabilities 0 from the Institute for the Protection of Bank Savings (IPAB), as well as the effect of the change in the valuation of public debt instruments, among other concepts.

Source: Banco de México.

Sep-13 Sep-14 Sep-15 Sep-16 Sep-17

Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18 5/ Data adjusted due to exchange rate variations. 6/ Data adjusted due to the withdrawal from and the incorporation of some financial intermediaries to the credit statistics. Includes credit from commercial and development banks, as well as other non- bank financial intermediaries. Source: Banco de México. Quarterly Report April - June 2018 17 Outline

1 External Conditions

2 Evolution of the Mexican Economy

3 Inflation

4 Monetary Policy

5 Forecasts and Final Remarks

Quarterly Report April - June 2018 18 Over the first five months of 2018, headline inflation decreased. Starting from June some of the upward risks signaled by this Central Bank have materialized: a depreciation of the national currency and higher prices of energy products. This led to considerable increments of non-core inflation, which remains at high levels.

Consumer Price Index Annual % change 13 12 11 10 Non-core 8.48 9 8 Headline 7 6 4.81 5 Core 4 3.60 3 2 Variability Interval 1 1F August

2011 2012 2013 2014 2015 2016 2017 2018 Source: Banco de México and INEGI.

Quarterly Report April - June 2018 19 Core inflation maintained a downward trajectory, in accordance with the previous forecast. This reflects the easing of the cyclical conditions of the economy, the exchange rate appreciation, as well as the effects of the implemented monetary policy actions, which have prevented second-round effects.

Real Exchange Rate and Relative Price of Core Price Index Merchandise and Services Annual % change Logarithm of index Dec-2010=100 Merchandise Services 5.2 9 9 Food, Beverages and Tobacco 5.1 Logarithm of 7 7 Real Exchange Rate 5.0 Services Education Logarithm of 5 5 4.9 Relative Price 1/

4.8 3 3 Merchandise 4.7 Housing 1 1 Non-food Merchandise 4.6 Other Services -1 -1 4.5 July 1F August 1F August 1F August

4.4 -3 -3

2011 2012 2013 2014 2015 2016 2017 2018

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 1/ This indicator corresponds to the logarithm of the ratio between the Source: Banco de México and INEGI. Source: Banco de México and INEGI. merchandise price index and the services price index. Source: Banco de México with data from Banco de México and INEGI. Quarterly Report April - June 2018 20 Fundamental core inflation remained below the levels of core inflation, and presented a slight downward pattern, due to the contraction of the economic activity in Q2 2018.

Core Inflation and Fundamental Core Inflation Annual % change 8

6 Core 5

2 Fundamental Core

1F August

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Source: Banco de México and INEGI.

Quarterly Report April - June 2018 21 Throughout the quarter, there were smaller impacts of merchandise prices on headline inflation, while the effect of the services prices remained stable. In turn, the contribution of non-core inflation has increased recently. Consumer Price Index (CPI) Selected Components of CPI Incidences in percentage points Annual % change and incidences in percentage points Gasoline L.P. Gas 30 2.0 45 1.0 8 25 40 1.5 35 Incidences (Bars)

Headline 20 Incidences (Bars) 30

6.77 6.63 6.66 7 0.5

6.44 15 25

6.35 6.31 6.37 1.0 Annual % Change (Line) 6.16 Annual % Change (Line) 20

5.55 10 5.82 15 6 0.5

5.34 5

5.35 10 0.0 4.86

Core 5.04

0 5 4.72 4.55 0.0

4.81 0 4.81 4.65 5 -5 Livestock 4.51 -5 1F August 1F August Fruits and Vegetables -10 -0.5 -10 -0.5

3.36 4

3.31

2015 2016 2017 2018 2015 2016 2017 2018

3.14

3.07

3.06 3.00

3.06 Core

2.97

2.87

2.88

2.87

2.74

2.61

2.73 2.60

2.65 Inflation

2.54 2.54 2.60

2.59 3 Merchandise Fruits and Vegetables 2.52

2.48 7 2.5 45 1.0 2.21

2.13 Incidences (Bars) Incidences (Bars) 40 0.8 2 6 2.0 35 Annual % Change (Line) 30 0.6 5 1.5 25 Non-core 0.4 1 20 4 1.0 0.2 Inflation 15 0.0 3 0.5 10 0 5 Energy -0.2 2 0.0 0 Annual % Change (Line) Government Approved Fares 1F August -5 -0.4 1F August -11.20 1F August

-1 1 -0.5 -10 -0.6

2015 2016 2017 2018

2015 2016 2017 2018 2015 2016 2017 2018 Source: Banco de México and INEGI. Quarterly Report April - June 2018 22 Outline

1 External Conditions

2 Evolution of the Mexican Economy

3 Inflation

4 Monetary Policy

5 Forecasts and Final Remarks

Quarterly Report April - June 2018 23 Monetary Policy Stance  To guide its monetary policy actions, the Governing Board closely monitors the evolution of inflation vis-à-vis its expected trajectory, considering the adopted monetary policy stance and the horizon at which it operates, as well as the available information on inflation determinants and medium- and long-term inflation expectations, including the balance of risks to inflation.  The Governing Board will maintain a prudent monetary stance and will continue to closely watch:  The potential pass-through of exchange rate expectations onto prices.  The relative monetary policy stance of Mexico and the U.S.  The evolution of slack conditions in the economy.  Given the presence and the possible persistence of factors that, by their nature, imply a risk to inflation and inflation expectations, the monetary policy will adjust in a timely and firm manner to attain the convergence to its 3% target, and to strengthen the anchoring of medium- and long-term inflation expectations, for them to reach this target.

Quarterly Report April - June 2018 24 Conduction of Monetary Policy

. It was considered the evolution of inflation and that the outlook of its main April and May 2018: determinants and their forecasts did not present important changes relative to the Rate unchanged at expected trajectory, although the Governing Board acknowledged that non-core 7.50% inflation remained high.

. It was considered that some risks to inflation started to materialize. In particular: June 2018:  Higher volatility of the Mexican peso and a greater depreciation. 25bp increase to  Greater-than-expected pressures on gasoline and LP gas prices. 7.75% . As a consequence, the balance of risks to inflation deteriorated.

August 2018: . It was considered the loosening of the cyclical conditions in the economy, that the Rate unchanged at expected trend of core inflation continues to the downside, and that the shocks that 7.75% recently affected inflation, in particular higher energy prices, are transitory.

Quarterly Report April - June 2018 25 Thus, the target for the Overnight Interbank Interest rate is at 7.75%. Based on these actions, and considering the evolution of 12-month inflation expectations, the short-term interest rate has increased to an ex-ante real level close to 4.0%. Monetary Policy Rate and Consumer Price Index Short-Term Ex-Ante Real Rate and Estimated Range for the Short- % and annual % change Term Neutral Real Rate in the Long-Term 1/ % 9 5 August August 1F August Short-Term Neutral Real Rate 8 4 Target for the Overnight Range in the Long-Term Interbank Interest Rate 7 3

Headline 6 2 Inflation

5 1 Core Inflation

4 0

3 -1 Inflation Target Short-Term Ex-Ante Real Rate

2 -2

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Source: Banco de México and INEGI. 1/ The short-term ex-ante real rate is constructed using the Target for the Overnight Interbank Interest Rate and 12-month inflation expectations from Banco de México Survey. The dotted line corresponds to the midpoint of the range. Source: Banco de México. Quarterly Report April - June 2018 26 The median of inflation expectations for the end of 2018 has increased since some risks to inflation began to materialize. However, the median of inflation expectations for the end of 2019 stayed around 3.60%, while the medians of medium- and long-term inflation expectations remained stable at 3.50%.

Inflation Expectations Break-even Inflation and Inflation Median, % Risk Implicit in Bonds Headline and Core Long-term 4.5 4.5 % 7.0 Headline Core Citibanamex Next 3-8 Years 6.5 2018 4.0 6.0 4.0 Next 4 Years 5.5 3.5 10-year Bond Break-even 5.0 Next 5-8 Years Inflation 3.5 3.0 4.5 Market Instruments 1/ Inflation Target 4.0 2019 2.5 3.5 3.0 3.0 2.0 20-day Moving Average August 2.5 July July August

2.5 1.5 2.0

2005 2008 2011 2014 2017

Jul-16 Jul-17 Jul-18

Jul-14 Jul-15 Jul-16 Jul-17 Jul-18

Jan-16 Jan-17 Jan-18

Jan-14 Jan-15 Jan-16 Jan-17 Jan-18

Oct-16 Oct-17

Apr-16 Apr-17 Apr-18

Oct-14 Oct-15 Oct-16 Oct-17

Apr-14 Apr-15 Apr-16 Apr-17 Apr-18

Source: Banco de México Survey (monthly periodicity). 1/ For a description of the estimation of log-term inflation expectations, see the Box Source: Estimated by Banco de México with data from Valmer and Bloomberg. “Decomposition of Break-even Inflation” in the Quarterly Report, October – December 2013. The estimate was updated by including data as of November 2017. Source: Banco de México Survey (monthly periodicity) and Citibanamex Survey (biweekly periodicity).

Quarterly Report April - June 2018 27 From the end of March to the first half of June, the national currency depreciated and its volatility increased, although subsequently it appreciated. This reflects the impact of the monetary policy actions, a lower degree of uncertainty in the wake of the presidential elections in Mexico, and a gradual improvement in the expected outcome of NAFTA renegotiations, which was supported by the recent announcements of a preliminary agreement for the modernization of the trade treaty with the U.S. Nominal Exchange Rate 1/ Implied Volatility in FX Options Pesos per USD % 24 24 Analysts’ Expectation 2018 Banxico 19.11 Analysts’ Expectation 2018 Citibanamex 19.17 23 22 Analysts’ Expectation 2019 Banxico 19.00 Analysts’ Expectation 2019 Citibanamex 19.07 22 20 1 Month Depreciation 21 18 18 Months 9 Months 20 16 6 Months 19 14

18 12 1 Week 17 10 Exchange Rate (as of August 28th) 18.94 August August

16 8

Jul-18

Jul-16 Jul-17 Jul-18

Jan-18

Jun-18

Jan-16 Jan-17 Jan-18

Oct-17

Apr-18

Sep-17 Feb-18

Dec-17

Sep-16 Sep-17

Aug-18

Nov-17

Mar-18

Nov-16 Nov-17

Mar-16 Mar-17 Mar-18

May-18

May-16 May-17 May-18 1/ Observed exchange rate refers to the daily FIX Exchange Rate. Numbers in front of the analysts’ Source: Bloomberg. expectations correspond to the averages in the Banco de México survey for July and the Citibanamex survey for August 21st, 2018. Source: Banco de México. Quarterly Report April - June 2018 28 Interest rates in Mexico increased moderately for all terms. Short-term rates reflected the increase in the target for the Overnight Interbank Interest Rate in June, while longer-term rates were affected by higher external interest rates.

Interest Rates Yield Curve % % 9 9.0 Aug 28th, 2018 8.5 Mar 28th, 2018 8 8.0 10 Year 1 Year 7.5 7 7.0 Dec 29th, 2017 1 Day 6.5 Sep 29th, 2017 6 6.0 5.5 5 5.0 2 Year 4.5 4 4.0 Dec 1st, 2015 3 Month 3.5 3 3.0 2.5 August 2 2.0

1 1 3 6 1 2 3 5 10 20 30

Jul-16 Jul-17 Jul-18

Jan-17 Jan-18

Jan-16 Months

Sep-17 Sep-16 Day Years

Nov-15 Nov-16 Nov-17

Mar-16 Mar-17 Mar-18

May-16 May-17 May-18

Source: Proveedor Integral de Precios (PiP). Source: Proveedor Integral de Precios (PiP).

Quarterly Report April - June 2018 29 In a context of a lower appetite for risk, Mexico-U.S. interest rate spreads for medium and long terms increased. Meanwhile, shorter-term spreads remained practically unchanged, although at high levels. In this juncture, government securities’ holdings by foreign investors remained stable.

Mexico and United States Interest Rate Volatility-adjusted 3-month Interest Rate Government Securities’ Holdings by Spreads Curve 1/ Spread for Selected Emerging Countries 2/ Foreign Investors Percentage points Index MXN billion 6.5 1.1 2,400 th Emerging Economies’ Average August August Dec 29 , 2017 1.0 Total 3/ 6.0 Mexico 0.9 Aug 28th, 2018 Range 2,000 5.5 0.8 th 0.7 Bonds Mar 28 , 2018 1,600 5.0 0.6 0.5 4.5 1,200 Sep 29th, 2017 0.4 4.0 0.3 0.2 800 3.5 0.1 Dec 1st, 2015 0.0 CETES 3.0 400 -0.1

2.5 -0.2 0

1 1 3 6 1 2 3 5 10 20 30

Jun-17 Jun-18

Oct-16 Oct-17

Apr-17 Apr-18

Feb-17 Feb-18

Dec-16 Dec-17

Aug-16 Aug-17 Aug-18

2015 2016 2017 2018 Day Months Years 2014 1/ The United States objective rate is the average of the interval considered by the Federal 2/ The selected countries are Brazil, Chile, Colombia, Turkey, South Africa, South 3/ The total includes CETES, bonds, udibonos, bondes and bondes D. Reserve. Korea and Poland. Source: Banco de México. Source: Proveedor Integral de Precios (PiP) and U.S. Treasury Department Source: Bloomberg. Quarterly Report April - June 2018 30 Outline

1 External Conditions

2 Evolution of the Mexican Economy

3 Inflation

4 Monetary Policy

5 Forecasts and Final Remarks

Quarterly Report April - June 2018 31 Economic Activity Outlook

Fan Chart: GDP Growth GDP Growth Annual percent, s. a. (%) 6 6 2018 2019 Report Jan-Mar 2018 Apr-Jun 2018 Observed Q4 Q4 2018 2.0 – 3.0 2.0 – 2.6 5 Central Scenario Previous Report 5 2019 2.2 – 3.2 1.8 – 2.8 Central Scenario Current Report

4 4

Increase in the Number of IMSS-insured Jobs (Thousands) 3 3 Report Jan-Mar 2018 Apr-Jun 2018 2018 680 – 780 670 – 770 2 2 2019 690 – 790 670 – 770 1 1

Current Account Deficit 0 0 (% of GDP) Report Jan-Mar 2018 Apr-Jun 2018 -1 -1 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 2018 2.1 1.9 2013 2014 2015 2016 2017 2018 2019 2019 2.3 2.1 s. a. / Seasonally adjusted data. Source: INEGI and Banco de México.

Quarterly Report April - June 2018 32 Risks to Growth Outlook The balance of risks to the economic growth of Mexico is biased to the downside.

Upward:

 That the recent announcements of a preliminary agreement for the modernization of the trade treaty with the U.S. lead to a recovery in investment.  That the greater-than-anticipated dynamism of the U.S. industrial production favors Mexican exports.  That a greater-than-expected public spending is registered.

Downward:

 That the escalation of protectionist measures affects global growth and trade negatively. Forecast horizon Forecast  That bouts of volatility in international financial markets are observed.  That the environment of uncertainty that has been affecting investment persists.

 That persistently weak investment has a more marked effect on Mexico’s productive capacity and the rate at which new technologies are adopted.  That the global protectionist measures negatively affect global value chains.

 That the competitiveness of the Mexican economy is affected by a number of external and domestic factors. long terms long

Medium and and Medium  That public safety issues, corruption, impunity and the lack of the rule of law become more pronounced.

Quarterly Report April - June 2018 33 With respect to the cyclical position of the economy, based on the estimated output trajectory, tight conditions are expected to continue relaxing.

Fan Charts Output Gap Estimate Output Gap Estimate Excluding the Oil Sector Quarterly Slack Index % of potential output, s. a. % of potential output, s. a.

6 6 6 6 3 3 2018 2019 2018 2019 2018 5 Q4 Q4 5 5 Q4 Q4 5 Q1 4 4 4 4 2 2 3 3 3 3 2 2 2 2 1 1 1 1 1 1 0 0 0 0 0 0 -1 -1 -1 -1 -2 -2 -2 -2 -1 -1 -3 -3 -3 -3 Central Scenario Observed Observed Current Report -4 -4 -4 -4 -2 -2 Central Scenario Previous Report Central Scenario Previous Report Central Scenario -5 Central Scenario Current Report -5 -5 Central Scenario Current Report -5 Previous Report -6 -6 -6 -6 -3 -3 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 2013 2014 2015 2016 2017 2018 2019 2013 2014 2015 2016 2017 2018 2019 2013 2014 2015 2016 2017 2018 2019 s. a. / Elaborated with seasonally adjusted data. s. a. / Elaborated with seasonally adjusted data. Note: The dynamics expected for this indicator is consistent with the forecasts for Source: Banco de México. Source: Banco de México. the output that excludes the oil sector. It is not feasible to calculate a fan chart for because of the nature with which the forecast was constructed. Source: Banco de México.

Quarterly Report April - June 2018 34 Inflation Outlook

 The inflation forecast considers that the higher-than-anticipated increases in energy prices, in a context in which non-core inflation was already at high levels, will affect the expected trajectory of annual headline inflation for 2019, although this effect is forecast to be transitory.

 Thus, it is projected that the trajectory of convergence of headline inflation to its target will be delayed, essentially, due to the evolution of non-core inflation.

 Core inflation better reflects the monetary stance and therefore, in this juncture, the Governing Board will monitor it especially closely.

 It is estimated that annual core inflation will continue to decline, reflecting both the monetary stance and the expected easing of the cyclical conditions of the economy.

Quarterly Report April - June 2018 35 Headline inflation is forecast to approach the 3% target during the rest of 2018 and in 2019, and starting from the first half of 2020 it will be positioned close to the target. This upward adjustment is attributed to a greater- than-expected contribution of energy products.

Annual Headline Inflation Forecasts Differences in Contributions to the Forecast % of Headline Annual Inflation Fan Chart 1/ Box Plot (Current vs Previous Report) 8.0 Next 8.0 6 0.8 Observed Inflation 4 6 7.5 QR QR 7.5 Central Scenario Previous Report Merchandise Energy 7.0 7.0 5 6.5 Central Scenario Current Report 6.5 4.8 Services Agriculture Government 0.6 6.0 Headline Inflation Target 6.0 4.2 4 Approved Fares 5.5 5.5 3.8 5.0 5.0 3.6 3.3 3.2 0.4 4.5 4.5 3.2 3.1 3 Headline 4.0 4.0 Inflation 3.5 3.5 2 0.2 3.0 3.0 2.5 2.5 1 2.0 2.0 1.5 2018 2019 2020 1.5 0.0 0 1.0 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 1.0 Current 4.6* 4.8 4.2 3.8 3.6 3.2 3.3 3.2 3.1 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 0.5 0.5 2018 2019 2020 Previous 4.6 4.3 3.8 3.3 3.1 3.1 3.1 3.1 -- Note: Box plots are presented to illustrate both the central 0.0 0.0 tendency and the range in which headline inflation could be -0.2 located. The diagram is composed of a box that is determined by Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 the interquartile range, which contains the intermediate 50% of 2013 2014 2015 2016 2017 2018 2019 2020 the distribution, and two arms determined by 1.5 times the size 2018 2019 2020 of this range. The median, which corresponds to the value of the 1/ Quarterly average of annual inflation. The next four and six quarters are indicated as of the third forecast, is located in the center of the box as the measure of Source: Banco de México. quarter of 2018, that is, the third quarter of 2019 and the first quarter of 2020, periods in which the central tendency, whereas the interquartile range represents the monetary policy transmission channels fully operate. */ Observed. Source: Banco de México and INEGI. measure of dispersion. Source: Banco de México. Quarterly Report April - June 2018 36 Core inflation is expected to continue subsiding, reflecting both the monetary stance and the projected easing of the cyclical conditions of the economy. It is also expected to reach a level of 3% in Q3 2019. Annual Core Inflation Forecasts % Fan Chart 1/ Box Plot Next 8.0 4 6 8.0 6 Observed Inflation 7.5 QR QR 7.5 Central Scenario Previous Report 7.0 7.0 Central Scenario Current Report 6.5 6.5 5 Headline Inflation Target 6.0 6.0 5.5 5.5 4 5.0 5.0 4.5 4.5 3.6 3.5 4.0 4.0 3.3 3.2 3 3.0 3.0 3.5 3.5 2.9 2.9 3.0 3.0 2.5 2.5 2 2.0 2.0 1.5 1.5 2018 2019 2020 1 1.0 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 1.0 0.5 Current 3.7* 3.6 3.5 3.3 3.2 3.0 2.9 3.0 2.9 0.5 Previous 3.7 3.6 3.4 3.2 3.2 3.1 3.0 3.0 -- 0.0 0.0 0 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2013 2014 2015 2016 2017 2018 2019 2020 2018 2019 2020 1/ Quarterly average of annual inflation. The next four and six quarters are indicated as of the third quarter of Note: Box plots are presented to illustrate both the central tendency and the range in which core inflation could be located. 2018, that is, the third quarter of 2019 and the first quarter of 2020, periods in which the monetary policy The diagram is composed of a box that is determined by the interquartile range, which contains the intermediate 50% of transmission channels fully operate. */ Observed. the distribution, and two arms determined by 1.5 times the size of this range. The median, which corresponds to the value Source: Banco de México and INEGI. of the forecast, is located in the center of the box as the measure of central tendency, whereas the interquartile range represents the measure of dispersion. Source: Banco de México. Quarterly Report April - June 2018 37 Risks to Inflation Outlook The balance of risks is still biased upwards, in an environment characterized by a high degree of uncertainty. Upward  That the national currency is pressured by an environment of higher external interest rates and the U.S. dollar’s strength, as well as by uncertainty in both the external and domestic environment.  That further increments in some energy prices and in the prices of agricultural products are observed. As a result, non-core inflation would hinder the convergence of inflation to the target.  That the U.S. trade actions lead to the escalation of protectionist and compensatory measures at the global level, which would negatively affect inflation.  That the greater-than-anticipated public spending lowers the pace at which core inflation is subsiding.

 Insofar as wage negotiations are not congruent with productivity gains, they could lead to cost pressures in the economy. Forecast horizon Forecast Downward  An appreciation of the Mexican peso in case the outcome of the recent announcement of a preliminary agreement for the modernization of the trade treaty with the U.S. is favorable. Upward

 That the real exchange rate shows a greater tendency towards depreciation.  That a situation of structurally weak public finances is presented.

Long term Long  That investment weakens further and low growth of productivity is accentuated, which, in view of the expansion of certain aggregate demand components, would make it more difficult to reduce inflation.

Quarterly Report April - June 2018 38 Final Remarks

 It is key to confirm the commitment to maintain a solid macroeconomic framework as a foundation for an economic policy that fuels the growth of the Mexican economy.

 It is important to acknowledge that the macroeconomic stability in itself is necessary but not sufficient to generate greater economic growth. It is also necessary to face structural and institutional challenges that could boost productivity, keeping in mind that, ultimately, the only way to generate better-paid jobs and decrease poverty on a sustainable basis is via greater productivity.

 In the same vein, it is necessary to invest in projects which provide the country with the infrastructure that contributes to strengthen the domestic market and to further benefit from Mexico’s export vocation across the country.

 It is essential to make progress in strengthening areas other than the economy, above all, those related to safety conditions and legal certainty.

Quarterly Report April - June 2018 39 Annex – Boxes

1 Evolution of Financial Volatility in Turkey.

2 Analysis of Investment Determinants.

3 Analysis of Inflation Dynamics using “Wavelets”.

4 Main Elements of the CPI Base Change.

5 Inflation-Targeting Regime Based on Forecasts.

Quarterly Report April - June 2018 40