SIM: double-digit inflation until 2010 - Second-round inflation effects more broad-based and deeper
April’s consumer inflation figures showed that the second-round effects of higher oil prices had become more broad-based and deeply entrenched than the previous figures, says Sanlam Investment Management (SIM) economist Arthur Kamp. This raises the risk that interest rates may increase by more than 50 basis points in June or August.
Notwithstanding the difficulties of forecasting inflation, Kamp says the April inflation figure suggests that, unless the oil price drops off sharply, inflation is likely to remain in double digits until the end of the year and is not likely to move back into its target band until 2010.
Kamp says large annual increases in food prices (up 15.9 percent year-on-year), running costs (25.3 percent year-on-year) were not the surprises. Of concern was the 2.3 percent increase in household consumer goods after a hefty 3.7 percent rise in March, as well as notable increases in furniture and equipment, recreation and entertainment and personal care prices.
It is becoming increasingly difficult for economists and the Reserve Bank to forecast inflation because a large component of the consumer inflation excluding mortgages (CPIX) is being driven by food and oil prices, which have been very volatile. Given this uncertainty, it is likely that the Bank will err on the side of caution.
Kamp says the broad-based nature of the price increases will worry the SA Reserve Bank. However he notes that this doesn’t mean that inflation is out of control. “The Bank started acting early in the cycle and the economy and domestic demand have started to slow materially.” A priority for the Bank is to control inflation expectations and wage demands, with expectations primarily backward-looking.
Beyond inflation pressures, economic growth is slowing, with first quarter gross domestic product (GDP) figures already showing a downward trend. Kamp expects growth to average 3.5 percent in 2008 but with a further interest rate hike expected in August, next year’s GDP forecast of 3 percent will be at risk.
