Lower PPI exceeds market expectations; strengthens case for continual interest rate cuts in 2009

The Numbers

PPI December 2008: 11% (year-on-year) vs 12.6% November
PPI December 2008: -1.1% (month-on-month)
PPI Average 2008: 14.2% vs 10.9% in 2007

Imported PPI December 2008: 3.4% (year-on-year) vs 6.3% November
Imported PPI December 2008: -1.4% (month-on-month)
Imported PPI Average 2008: 16.5% vs 9.6% in 2007

Exported PPI December 2008: 4.8% (year on year) vs 11.2% November
Exported PPI December 2008: -5.7% (month on month)
Exported PPI Average 2008: 8.1% vs 13.5% in 2007

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Introduction

South Africa’s production price index (PPI) in December continued its lower rate of increase since August 2008 mainly on account of sharp drops in the prices of mining commodities and a lower oil price. PPI for December registered and increase of 11% (12.6% in November) which is 1.1% lower than November. The average for the year was 14.2% compared to 10.9% in 2007.

However, as the composition of the PPI changed from January 2008, the averages (and the monthly numbers) are not comparable – especially as the new PPI includes products for exports (which are not consumed in South Africa and thus in effect renders the new PPI irrelevant for CPI purposes). When the comparable PPI is calculated (in order to determine the PPI for consumption in South Africa and thus its impact on CPI), the average for 2008 is 16.3%.

However, at 10.4% the comparable PPI for December was lower than the official 11% as it excludes the 4.8% increase in the PPI for exports and assigned a larger weight to the PPI for imports, which increased at a lower rate of 3.4%.

Analysis

On a year on year basis, the PPI for basic metals was responsible for 33.6% of the total increase of 11% in PPI in December, making it the main driver behind the increase in PPI. Combined with electricity (15.5%) and chemicals and chemical products (10%), the contribution to PPI from these three groups is almost 60%.

The month on month calculations reveals a reduction of 1.1% in the PPI. This is mainly due to the sharp drop in commodity prices. The mining and quarrying sub-index declined by 2.6% between November and December. As such its contribution to the -1.1% drop in PPI was -0.5%. The decline was mainly as a result of crude petroleum and gas which dropped by 9.1% on a month on month basis, metal ores which was 6.7% lower and other minerals which dropped by 7.6%. In addition, products of petroleum and coal (such as diesel) declined by 12.9% on a month on month basis and as such contributing -0.9% to the drop in the monthly PPI. These drops were however marginally countered by an increase in electricity and agricultural products which collectively was responsible for a 0.3% contribution in the monthly PPI.

Table 1

Outlook

PPI should continue its downward trend during the course of 2009, dropping to below the upper inflation target level of 6%. Lower international commodity and agricultural prices and a high base of calculation should assist in this process. However, the weaker rand exchange rand will prevent a sharper drop in PPI going forward.

Interest rates

The lower comparable PPI for CPI purposes (10.4% compared to 11%) shows that the pass through from the producer to consumer should be much milder in 2009. As such, the repo rate will be lowered in February. Though the Monetary Policy Committee will, as in December, consider a reduction of 100 basis points, various uncertainties might render it prudent to wait till April for such action. At that time more clarity on the impact of the budget, the depth of the financial crisis on the world economy, the weakening of the rand and of the new CPI-basket on consumer prices, will be available. Therefore, a reduction of 50 basis points next week will be the more prudent action