CPI – another good inflation surprise

CPI, which rose to 6.3% in December, was not only better than the market anticipated but also far better than the Reserve Bank’s expectation. Yes, it is above the target band, but that is largely because we had the unusually large drop of almost R2 in petrol prices in December 2008, so this is entirely a statistical base effect.

The underlying trends are very encouraging. December marks the second month of negative food prices and we are clearly seeing the beginning of food deflation. Underlying soft commodity prices have fallen sharply in recent months, hence we expect the trend in food prices to gather momentum.

The benefits of the strong rand for inflation is also coming through strongly now. Vehicles prices, for example, are down for the second month in a row and furniture prices are also on the decline.

In addition, several services items surprised on the downside. The only exception to this improvement is the hospitality industry, where prices appear to be accelerating. This will probably only get worse in the months to come, as it so obviously a case of prices going up into the 2010 World Cup. We expect the monetary authorities to ignore this trend, as prices will most certainly drop to more realistic levels after the event.

Inflation will remain outside the target band for January as well, but again this will be purely a base effect. After that, it should subside quickly towards the middle of the target band. The Reserve Bank has a more cautious inflation forecast than this, so a good number like the one we had today means that they will have to revise their forecast down, thus raising the prospects of a rate cut in March.