Weak economy taking its toll on price increases

Introduction

The CPI for June declined to 6.9% but remained high for a country in the midst of a severe economic recession. Though a large part of the smaller increase can be attributed to a high base of calculation, analysis shows that price increases are indeed slowing.

In addition, the prices of 27% of the main items in the inflation basket which collectively make up 17% of the average consumer’s consumption spending actually declined between May and June.

This can be attributed to mainly the weakening state of the South African economy as portrayed by amongst others the credit- and money supply growth numbers. The pace of credit extension to households slowed to 4.6% in June from 5.3% in May. Interestingly credit extension actually declined by -1% from Q1 2009 to Q2 2009. Though this might point to weakening inflation pressure and as such a call for a further reduction in interest rates, it also states how weak the economy really is.

Analysis

Big four

The CPI of the BIG FOUR, with a combined weight of 50.34% in the CPI basket, declined to 6.7% (see Table 1). This is mainly as a result of smaller increases in the CPI for food, rent and vehicles. A heartening fact is that the year over year increase in unprocessed food was limited to 10.9% (13.2% in May) due to a monthly decline of -0.8%. The declining increase in rent and owners’ equivalent rent also points to a weakening economy with consumers not being able to afford the high increases of the past.

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

Interest rate sensitive inflation

Interest rate sensitive CPI declined from 8.8% to 7.9% in June. The smaller increase notwithstanding lower interest rates – which should under normal circumstances encourage consumer spending and as such put upward pressure on the CPI – can be attributed to a weakening demand. With more than 475 000 jobs lost during the first six months of the year (QLFS Q2 2009) disposable income should have declined thereby putting downward pressure on spending.

In contrast, non-interest rate sensitive inflation declined to 4.2% which is in the inflation target band. This number normally is above the inflation target band. The reason for the decline can be attributed to the price of petrol which is 25% lower than a year ago. Without petrol, administered prices registered an increase of 9.1%.

Conclusion and interest rate outlook

South Africa’s CPI will struggle to dip below and then remain in the target band of 6% to 3%. A high base of calculation coupled with slowing and decreasing prices might see CPI declining to within the target band soon. However, a low base of calculation from September onward will have a reverse effect on CPI.

Regarding the economic outlook, the credit growth numbers and lower CPI points to a still deteriorating state of production. As such spending and income also weakened with a larger weakening in spending. The imbalances in the economy therefore also reduced.

The above factors leave room for more reductions in interest rates. However, without an upturn in international demand to stimulate the local economy, the role of lower interest rates will be limited.