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Inflation peak approaches as longer-term outlook improves

23 July 2008 Rian le Roux , Head of Economic Research at OMIGSA

A recent brightening in South Africa’s longer-term inflation outlook means consumers can start to expect the peak in our interest rate cycle sooner rather than later, and can possibly look forward to quicker cuts in rates as well, barring unexpected shocks, according to Rian le Roux (pictured), head of economic research at Old Mutual Investment Group (SA) (OMIGSA).

“There’s good news for consumers in the latest developments around the rand, the coming revamp of inflation data and even the sharp slowdown in economic growth,” says le Roux. “Taken together, they have contributed to a notable lowering of our inflation forecasts for 2009. What this means is that we can possibly look forward to an earlier decline in interest rates in 2009 than we previously expected.”

Le Roux expects CPIX to peak at around 13.5% in the next few months, and then to fall gradually through the end of 2008, with a sharper decline in 2009 and reaching the 3-6% inflation target by the third quarter of 2009. The risk of further hikes has receded notably, although it has not disappeared completely.

“We have also brought forward our forecasts for interest rate easing, now beginning from mid-2009 rather than late 2009. However, we expect the down-cycle in interest rates to be fairly gradual rather than sharp, as we will still be facing a number of obstacles like increases in electricity prices, high inflation expectations and high wage rises, amongst other negative factors.”

He says the surprisingly sharp economic slowdown seen recently has shown that the past tightening in monetary policy is working very well to curb the consumer, and the latest 50bp hike has yet to make itself felt. Certain sectors like vehicles, property residential contractors and durable goods retailers are already experiencing recessionary conditions.

“With the economy now fully in the grips of high interest rates and also factoring in the impact on inflation of the new weights to be implemented next year, the SA Reserve Bank may be less likely to raise rates further,” le Roux explains. “There is also a growing perception that South Africa may be ‘ahead’ of other emerging market economies in the painful adjustment process to high global inflation pressures. Whereas some central banks have been slow in raising interest rates, the SARB has not, so we are well advanced in the adjustment process. This has also bolstered the rand to some extent.”

Despite the sharp slowdown underway led by consumer spending, the economy is very unlikely to move into outright recession, he says. Growth is supported by government and private sector spending on infrastructure and related areas, as well as social programmes. He expects GDP growth to average a little over 3% both this year and 2009.

On the planned revision of the inflation basket from 2009, Le Roux explains that it could lower inflation by about 1.5 to two percentage points in 2009 compared to predictions using the existing weights. “These revisions to various weightings are to be welcomed, since consumer spending patterns have shifted significantly since the last update.”

On top of this, there are other positive developments that indicate we are rapidly approaching or have already arrived at the top of the interest rate cycle, le Roux says. These include:

1) The slowing economy is blunting pricing power for companies (so it is becoming more difficult to pass on price increases);
2) The rand has been holding up well (thanks mostly to the high interest rate differential with most countries) and
3) There are positive signs on food inflation (inflation at the producer level have fallen sharply in recent months).

Of course many risks still abound for the South African economy going forward. The biggest threat to le Roux’s forecasts is a further sharp rise in inflation in the next few months, sparked by higher oil, food or electricity prices. Key risk factors also include the high wage settlements now being reached in various industries and inflation expectations, which have deteriorated rapidly this year. Globally, slower growth and high inflation, a potential fall in commodity prices and the threat of a weaker rand (due to the large current account deficit) also pose further risks.

In conclusion, le Roux observes: “Overall, we are definitely starting to see reasons to believe that the current interest rate cycle is in peak territory and that interest rates could start to come down from mid-2009, once the inflation downtrend is established and inflation expectations adjust downward again. Although the risk of external shocks is still high, consumers do now have some light at the end of the tunnel – the cycle is finally looking shorter and friendlier for them.”


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