manuel sanchez : the mexican economy in difficult times remarks by mr manuel sanchez, deputy governor of the bank of mexico, at the jp morgan 7th annual mexico ceo conference, mexico city, 31 july 2012. * * * thank you for inviting me to speak to you today. it is a pleasure to participate in the annual jp morgan mexico ceo conference and share my thoughts with you on mexico ’ s economic outlook and challenges. as you know, the world economy is going through difficult times, characterized by low growth prospects and financial and fiscal problems in many developed countries. i would like to focus my comments today on how this external scenario is constraining the mexican economy, and what tasks await on the domestic front. my main message will be twofold. first, although mexico ’ s ongoing economic recovery from the global financial crisis of 2008 seems to be firmly grounded, its continuation and possible strengthening are highly dependent on future global economic conditions. second, in order to enhance its growth potential, mexico should confront its domestic challenges, including those related to the consolidation of price stability. as always, my comments are entirely my own responsibility and do not necessarily reflect the views of the bank of mexico or its governing board. economic developments and outlook during 2012, mexico has continued a process of economic recovery which began in the middle of 2009. in the first quarter of this year, gdp increased 4. 6 percent versus a year ago, a rate that surpasses the growth observed both in the first and the last quarters of 2011. all major demand components expanded significantly, especially exports of goods and services and domestic investment. available data suggest that this upward trend continued during the second quarter. in particular, during april and may, year - over - year growth as measured by the global economic activity indicator ( igae ), a monthly gdp proxy, averaged 4. 4 percent, with its two main components, the industrial and services sectors, showing considerable momentum. monthly contraction of industrial production in may was mainly due to a slowdown in the production of transportation equipment, as a result of temporary closures of some auto plants for production line retooling. indeed, auto production in june picked up. furthermore, the services sector continued to expand year over year. on the demand side, manufacturing exports since april continued to be a significant source of growth, with shipments increasing both to the united states and to the rest of the world, of both automotive and non - automotive products. although preliminary figures for june suggest that manufacturing exports may

cyclical outlook, which continues to be highly uncertain. the increase in short - term interest rates has accentuated the rise, underway for some months now, of long - term rates, which play a key role in the economic activity of firms and households. compared with the first ten days of december, on the eve of the change in monetary policy made by both the federal reserve and the ecb, the 10 - year interest rates rose by 185 basis points in the united states, by 200 in germany and by 230 on average in the euro area. it seems difficult to reconcile the relative size of these rises with a situation in which core inflation in the euro area is more than 2 points lower than in the united states and wage growth is over 3 points lower. this is therefore a development that we will have to monitor carefully in the coming months to ensure that financial conditions do not tighten excessively, including a disproportionate increase in long - term interest rates, also considering, if necessary, a recalibration of the path of increases in the key interest rates, which is not predetermined but depends on the evolution of the economic and financial situation. the pace of monetary policy normalization has to balance two risks. if it is too gradual, inflation could become rooted in expectations and in wage - setting processes, with the risk of compromising the credibility of the central bank and forcing it to adjust its stance, with more marked repercussions for economic activity and employment. on the other hand, if the pace is too fast or its announcement wrongly interpreted, markets could overreact and the tightening of financial conditions could be stronger than necessary, with risks to financial stability, economic activity and, ultimately, price developments, which have only recently been forecast to reach 2 per cent in the medium term. if on the one hand, abandoning the policy of negative key interest rates can no longer be precluded, on the other hand, i believe it to be crucial that, as announced, the normalization of monetary policy continues in a gradual fashion, and with great attention paid to the uncertain evolution of the economy and of financial conditions. only in this way will we be able to preserve and consolidate the wealth of credibility that we have built up over time. the risk of market fragmentation in the euro area on top of its vulnerability to the risk of general financial tensions, the euro area, being a monetary union, is exposed to the equally dangerous risk of unjustified capital