Introduction
Since central banks gained independence in controlling inflation, they introduced the concept of underlying inflation. This measure emerged as a response to the volatility observed in general price indices, which sometimes reflected temporary factors or prices that were difficult to predict in the short term.
The Rise of Underlying Inflation
Central bankers decided to focus more on the sample represented by goods and services with more stable price movements. This approach aimed to enhance the effectiveness of monetary policy decisions for inflation control.
Today, underlying inflation remains a central reference but no longer operates as the sole factor determining the pace of interest rate adjustments. Both in Mexico and the United States, central bank decisions reflect a broader interpretation of the inflation cycle and the degree of effective monetary policy restriction.
US vs. Mexico: A Tale of Two Inflation Measures
In 2025, the US general inflation was 2.7%, while underlying inflation stood at 2.6%. The latter has shown a more pronounced downward trend in the last two reports. In contrast, Mexico’s general inflation was 3.69%, with underlying inflation at 4.33%, displaying persistence in recent months and a brief upward trend.
Part of this difference lies in the fact that underlying inflation measures different aspects in each country. In the US, energy prices and both processed and unprocessed food items are excluded from general price indices for core (underlying) calculation. In Mexico, processed foods are part of underlying inflation, while unprocessed items (perishables, fruits, and vegetables) are classified as non-underlying. This implies that the Mexican underlying inflation incorporates pressures not accounted for in the US, making it structurally stiffer and less comparable internationally.
Implications for Interest Rates
These differences start to paint a picture regarding the determination of reference interest rates. The closure of underlying inflation in the US failed to excite investors, despite its downward trend.
Upon reviewing alternative calculations of underlying inflation, an upward-biased inflation trend towards 3% levels is observed. These alternative measures exclude extraordinary movements, housing prices, and other factors.
With midterm elections in the US less than 11 months away, affordability of goods and services, particularly food and energy (non-underlying, mainly electricity and gas), has become a central issue. Investors and analysts estimate that the Fed will only cut its rate twice, despite weak employment and subsiding underlying inflation pressures.
Political Influences on Central Bank Decisions
The political landscape in the US has weakened since a year ago, with disappointing local election results for Republicans and the Epstein scandal. Persistent inflation in key categories like basic goods and food, along with signals of weakening employment, suggests that the government will exert maximum pressure to alter the Fed’s criteria and lower interest rates if the executive branch decides who will lead it.
Mexico’s Unique Context
Underlying inflation pressure has led to dissent within Mexico’s Governing Board, which seems to have intensified towards the end of the previous year, according to recently published minutes. The Governing Board acknowledges that the inflation risk balance maintains an upward bias.
Although general inflation has decreased, the process remains unconsolidated, and underlying inflation persists, particularly in services and processed foods. Additional factors like IEPS increase, labor cost rises (mainly minimum wage), and higher tariffs on imports from countries without a trade agreement with Mexico limit space for further relaxation (reduction of the reference rate).
Another variable, the real ex ante rate (the interest rate minus expected inflation over the next 12 months) in Mexico is very close to its neutral level. As inflation has decreased, the monetary policy stance has automatically adjusted, reducing restraint without additional nominal rate movements.
From a strictly orthodox perspective, the Fed could lower rates, while Banxico in Mexico should pause its rate reduction. Market participants hold this view, acknowledging that central banks face pressures challenging their independence.
Key Questions and Answers
- What is underlying inflation? Underlying inflation measures the change in prices of goods and services, excluding volatile items like food and energy, to provide a clearer picture of long-term inflation trends.
- Why is underlying inflation important? Central banks use it to make informed decisions about monetary policy, such as interest rate adjustments, to maintain price stability and control inflation.
- How do the US and Mexico differ in measuring underlying inflation? The US excludes energy prices and both processed and unprocessed food items from general price indices for core calculation. Mexico, however, includes processed foods in underlying inflation while classifying unprocessed items as non-underlying.
- What are the implications of these differences for interest rates? These discrepancies can lead to varying interpretations of inflation trends and, consequently, different approaches to adjusting interest rates by central banks.
- How do political factors influence central bank decisions? Political pressures, such as upcoming elections or scandals, can impact central bank independence and lead to decisions that prioritize short-term goals over long-term price stability.
