Structural problems keep CPI high

Introduction

The CPI for May declined to 8% but remained high for a country in the midst of a severe economic recession.

From the numbers it is clear that economic theory of demand and supply has little impact on the price determination process. For example, though consumption spending shrank by 8.7% in Q1 2009 (from Q4 2008), the quarterly annualized CPI increased by 6.1% over the same period. This implies that South African companies rather increase than decrease their consumer related prices during times of an economic contraction.

A good example is durable goods. According to the Reserve Bank’s latest quarterly bulletin spending on durable goods contracted by -19.2% in Q1 2008 (compared to Q4 2008 annualized and seasonally adjusted). However, the CPI for durable goods (with a weight of 14.79% in the CPI basket) increased by 4.9% in May. This can be attributed to mainly the increase in prices of new motor vehicles – notwithstanding a drop in sales of more than 35%.

Similarly, the CPI for non-durable goods increased by 9.2% in May despite the Reserve Bank’s calculations showing a seasonal adjusted and annualized contraction in spending of -12.2% in Q1 2009. This can be attributed to the continual high increase in prices of food.

Analysis

Big four

The CPI of the BIG FOUR, with a combined weight of 50.34% in the CPI basket, increased to 7.9% (see Table 1). This is mainly as a result of the steep increase in the prices of new vehicles. Though the vehicle price index increased by only 4.8% in May, the increase was much higher compared to April and occurred despite a reduction in the prices of used vehicles. This increase neutralized slower increased in the other price categories.

Table 1: Increases in big four items slower than the rest of the CPI basket

The increase in the price index for food and non-alcoholic beverages slowed from 13.7% in April to 12.1% in May. However, this can be attributed to a very high base of calculation. In May last year the annualized monthly increase in this category was 24% providing for a smaller year over year increase in May 2009.

Interest rate sensitive inflation

Interest rate sensitive CPI increased from 8.6% to 8.8% in May. However, this can’t be attributed to the sharp reduction in interest rates since December this year. Rather, it is the consequence of the above mentioned lack of competition which allows cost increases to be passed on to consumers. Higher interest rates won’t be able to curtail price increases stemming from collusion between companies to fix prices.

Other drivers

Another driver of CPI in May was the hefty increase in hospital tariffs. According to Stats SA this increase was 1.5% between April and May – the largest monthly increase of all categories. This caused the year over year increase to jump from 8.8% in April to 10.5% in May.

Conclusion and interest rate outlook

South Africa’s CPI will struggle to dip below the upper target level of 6% - not only this year, but for as long as price fixing (via collusion) is allowed in the economy. In these conditions interest rate increases will struggle to bring inflation down.

As for tomorrow’s interest rate decision, economic theory advices against another drop in the repo rate as inflation is already higher than the repo rate and as such distorts the price of money. However, the MPC might reduce interest rates by another 50 basis points due to the weakening economy and pressure from outside parties.