Steer clear of taking on more debt

Rian le Roux, chief economist, Old Mutual Investment Group SA

Economic data and developments over the past month have not been promising. Inflation has continued to surprise on the upside, petrol prices rose sharply further early in June, electricity tariffs are set to rise sharply and economic growth is slowing under the dual impact of higher interest rates and the earlier electricity outages.

But, for now, the attention is squarely on the outlook for inflation. Already at a five year high of 10.4%, CPIX inflation is set to rise further in coming months. Moreover, inflation expectations are rising and wage settlements are accelerating, clouding the longer term outlook for inflation too. Under these conditions the Reserve Bank has no choice but to maintain its hawkish stance o¬n monetary policy. Following warnings from Tito Mboweni over the past week or so, it now looks virtually certain that the Reserve Bank will raise rates by 100 basis points next week.

This will bring the cumulative increase in rates since the tightening cycle started in 2006 to 550 basis points, a much bigger rise than was generally expected. And, worst, yet more tightening may follow later in the year.

The economy, in the meantime, has clearly started to reflect past monetary policy tightening. During the first quarter GDP growth slowed to 2.1% annualised, down from over 5% in the final quarter of last year. This was the slowest growth pace in more than six years, although the electricity interruptions contributed to the slowdown. The impact of the higher interest rates is far more evident in interest rate sensitive sectors such the car- and property markets. New passenger car sales are already down 37% from the peak reached in mid-2006, while latest data from ABSA indicates that house prices have actually started to decline in nominal terms over the past few months.

Looking forward, prospects are not promising for the remainder of 2008 and 2009. While the improvement in the electricity situation over the past few months will likely cause a bit of a bounce-back in GDP in the second quarter, it is likely to slow again during the second half of the year as higher interest rates and rapidly deteriorating consumer and business confidence take their toll.

For the year as a whole, growth is expected to be a little over 3%, notably slower than the ±5% of the past 4 years. The growth slowdown will likely carry on in 2009 as little relief seems likely from interest rates before deep into the year, if, indeed, at all. So, depressed consumer and business confidence and slowing global growth will take their toll and growth is expected to at best match this year’s performance. A deeper slowdown will likely be prevented by a further acceleration in the infrastructure expansion programme of the public sector.

The environment sketched above clearly implies a very difficult period for most consumers over the next year or so. While higher salary increases will provide some relief against the recent and coming price and interest rate shocks, conditions will remain very difficult for some time to come still and financially strapped households remain strongly advised to steer clear of taking on more debt.