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Food inflation likely to remain high through 2008

16 July 2007 Old Mutual Investment Group SA (OMIGSA)

Food price inflation is likely to remain above the South African Reserve Bank (SARB)s inflation target band of 3-6% CPIX (headline consumer inflation less mortgage rate changes) for the foreseeable future, thus maintaining pressure on local interest rates and consumers budgets, according to Johann Els, Senior Economist at Old Mutual Investment Group SA (OMIGSA)'s Economic Research Unit.

Food has by far the largest weighting in the CPIX measure at 25.66%, and rising food prices have been one of the largest contributors to the recent jump in CPIX; food inflation measured an alarming 9.0% y/y in May, contributing 2.4 percentage points to May's 6.4% CPIX increase.

Els points out that food inflation has stemmed predominantly from key staples like grain products (up 11.4% y/y in May), meat (also up 11.4%), and fats and oils (12.7% higher). Even the prices of milk, cheese and eggs rose 8.3% y/y in May, well above the SARBs upper target limit.

He attributes these price pressures to several factors, including sharply higher international food prices and local supply constraints such as a smaller maize crop and shortages in milk.

"Consumers in the very low and low income brackets (as defined by StatsSA) are facing general food inflation of 10.7% y/y and 10.1% y/y, respectively," notes Els. "These are the highest rates in several years. This means consumers who spend a large proportion of their income on food are under increasing pressure from double-digit price increases that are difficult for them to pay for."

Although he does expect some downturn in food inflation as larger grain plantings, amongst other supply factors, help to bring prices down over time, the lowest point in the price cycle is not likely to fall below the SARBs 6% upper CPIX limit until at least the end of 2008, Els believes.

"Our forecast is for food inflation to stay above the key 6% level through 2008, due again largely to the influence of international prices and local supply constraints," he explains.

Some good news for consumers is that prices for other consumer goods like clothing, footwear, furniture, appliances and vehicles are likely to remain in check thanks to ongoing tough competition at the retail level and the impact of globalisation. Clothing and footwear recorded price deflation of -7.1% y/y and -11.2% in May, respectively.

As for the overall measure of CPIX, Els does expect it to return within the SARB's target band this year. However, with heavyweight food prices and continued high oil prices - putting upward pressure on CPIX levels for the foreseeable future, he anticipates CPIX will remain mostly in the upper half of the band through 2009.

Factors that could influence this inflation forecast negatively include rising unit labour costs as workers negotiate higher wage settlements, higher inflation expectations amongst the public in general, and the "unforecastable" risks of the oil price, the exchange rate, and international food prices.

Among the positive risks he points to are: a stronger-than-expected rand; ongoing margin pressures for retailers stemming from competition and globalisation; and downside surprises for the prices of oil and food.

Els sees the interest rate decision by the SARBs Monetary Policy Committee at its August meeting as another close call, but does expect the Bank to hike interest rates by 50 basis points in an attempt to negate the risks of high wage growth and rising inflation expectations.

"Consumer demand and credit growth are both slowing, and we dont yet know the extent of the impact of the National Credit Act," he points out. "But will this be enough to offset renewed inflation risks?

"The MPC will also certainly worry about the high level of wage settlements and their impact on expectations and future inflation. The rand has been firm, but is vulnerable to adverse global developments and rising risk aversion. The oil price remains unpredictable, and the wild card will be how the MPC views slowing manufacturing production," Els concludes.


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