Rising risks of a more severe inflation and interest rate cycle
The spate of negative local economic data released last week has almost sealed the case for a further 50bp rate hike by the Reserve Bank coming Thursday.
There is also a risk that rates may have to be raised even further later in the year, says Old Mutual Investment Group SA (OMIGSA) chief economist Rian le Roux.
While US economic data last week came in better-than-expected, confirming that the world's largest economy is not on the brink of a fully fledged recession, local inflation and credit data became the latest triggers for what is likely to be another 50-basis point interest rate hike at this week's Monetary Policy Committee meeting.
Le Roux says: "We have long held a structurally optimistic view of the SA economy but have emphasised that a cycle is likely to occur within that given the presence of a number of global and local risks."
The first, which appears to be materialising at present, is the risk of a further rise in inflation. Last week Statistics SA released a surprise figure that showed consumer inflation excluding mortgages (CPIX) had breached the upper end of the Reserve Bank's target range. Though we do expect inflation to continue on its downward trend to about 5.5% by year-end, the cumulative 92c a litre, or 16.5% surge in the petrol price in March and April, have played a key role in the recent rise in inflation, along with still rapidly rising food prices.
Says Le Roux: "While monetary policy can do little to counteract price pressures from these two sources, there is a real risk that the lengthy cyclical uptrend in inflation from its 3.1% lower turning point in February 2005 will eventually begin to drive up inflation expectations and wage demands." He points out that inflation expectations have remained well anchored so far but would begin to drift notabl y higher if inflation remains at current levels for some time or drifts higher.
The second potential risk is the still large deficit on the current account of the balance of payments, especially given the likely further acceleration in investment spending. "While the shift in demand away from consumption towards investment is a welcome development in itself, the overall sustained rapid growth in domestic demand still holds serious risks to the balance of payments and, hence, the rand because it typically has a higher imported component."
Le Roux says under these circumstances, the current account deficit is likely to remain large and will require monetary policy to remain relatively tight, possibly for an extended time. "Should global conditions deteriorate and/or commodity prices ease notably, even higher rates may be required."
However, he believes that fears of a severe global downturn are overdone. "Our key views on the global economy are three-fold: firstly, we think that an outright recession in the US is unlikely, although this clearly remains the biggest downside risk to the world economy; secondly, we believe that the rest of the world is currently much better placed to withstand a slowdown in the US as growth is increasingly supported by domestic growth dynamics; and thirdly, we believe that emerging market growth will remain structurally strong for a prolonged period, driven increasingly by large infrastructure investment programmes and structurally firming consumer demand."
Thus, on the local front, Le Roux notes that looking further out OMIGSA's long-held optimistic view of prospects for the domestic economy remains unchanged.
