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Second round inflation on the retreat?

26 November 2008 Dynamic Wealth

The Numbers

 

CPIX October 2008: 12.4% (year-on-year) vs September 13.02%
CPIX October 2008: 0.2% (month-on-month)
CPI October 2008: 12.1% (year-on-year) vs September 13.1%
CPI October 2008: 0% (month-on-month)

The meaningful decrease in the CPIX for October to 12.4% confirmed that the upper turning point was indeed reached at 13.6% in August.

Though a downward trending inflation rate alone is not enough ammunition for an early reduction in the repo rate, the motivation for such reduction might be found in second round inflation which might have reached its peak in September.

Moreover, the case for reducing the repo rate on 11 December is reinforced by the sharp slowdown in economic growth for the third quarter (from 5.1% in Q1 to 0.2% in Q3 on a QoQSAA basis).

In addition, with the G-20 countries deciding on coordinated action in order to prevent a severe drop in international economic activity, the confirmation of slowing inflation will contribute to the reason for an early cur in interest rates.

Other factors which will contribute to the Monetary Policy Committee considering an early reduction in the repo rate include the slowdown in credit growth and money supply growth.

Though the problems associated with financing the large current account deficit might in some circles be a viewed as a deterrent to a reduction in interest rates as the high yields are supposed to attract foreign capital, recent history proved that foreign capital is attracted largely by better company profit and thus economic growth prospects. As lower interest rates will improve companies’ profit outlook, it may attract more portfolio capital inflows than higher interest rates.

Looking more closely at the inflation numbers, both interest rate sensitive and non-interest rate sensitive inflation increased at a slower pace. Non-interest rate sensitive inflation, including administered prices, reached its peak in August at 20.4%. Due to especially the drop in the petrol price and slower increases in food prices this component slowed to an increase of 17.6%.

The interest rate sensitive component, which provides an indication of second round inflation, decreased marginally from 8.1% in September to 8% in October. This shows that weakening demand is forcing producers and retailers to cut back on excessive price increases notwithstanding increasing cost pressure.

Month

 

 

 

CPIX

 

 

(% Change)

Food

 

 

(% Change)

CPIX Excluding  Food and Running Costs

 

(% Change)

Interest Rate

Sensitive

CPIX

 

(% Change)

Non-Interest Rate

Sensitive CPIX

 

(% Change)

Jan '07

5.30

8.3

3.71

3.49

7.46

Feb'07

4.93

7.9

3.83

3.63

6.47

Mar '07

5.48

7.8

4.21

4.08

7.16

Apr '07

6.32

8.6

4.53

4.51

8.48

May'07

6.36

9.0

4.50

4.52

8.54

Jun '07

6.40

9.4

4.58

4.67

8.45

Jul  '07

6.47

10.2

4.92

4.71

8.56

Aug'07

6.30

11.3

4.84

4.51

8.43

Sep'07

6.70

12.0

4.77

4.55

9.26

Oct '07

7.32

12.4

4.69

4.47

10.70

Nov'07

7.88

13.3

4.82

4.66

11.71

Dec'07

8.57

13.9

4.93

4.80

13.06

Jan '08

8.76

13.6

5.48

5.43

12.72

Feb '08

9.39

14.3

5.50

5.54

13.98

Mar '08

10.05

15.6

5.59

5.68

15.26

Apr '08

10.41

15.9

6.06

6.29

15.31

May‘08

10.95

16.9

6.18

6.58

16.14

Jun ‘08

11.56

18.2

6.26

6.78

17.24

Jul '08

13.01

18.5

7.41

7.33

19.77

Aug ‘08

13.63

19.2

8.24

7.90

20.44

Sep ‘08

13.02

17.9

8.59

8.14

18.81

Oct ‘08

12.4

17.2

8.47

8.0

17.59



Another indication that the pressure of second round inflation may be receding can be found in the CPIX excluding food and running costs (including petrol). This indicator shows an increase of 8.47% in October which is marginally lower than the 8.59% in September.

Regarding the outlook for inflation, the expected sharp drop in the petrol price of R1.60/l next week may reduce the CPIX for December to close to 10%. Adding the impact of the technical change in inflation from January onwards due to changes in the weights and basket, the CPI for January will be below 9%.

As this will increase the real interest rate to above the international norm of 5% to 6%, it leaves enough room for the MPC to reduce the repo rate in December – if it is indeed forward looking.

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