Category Investments

Getting aggressive

20 July 2006 Angelo Coppola

Welcome to the world of inflation targeting and aggressive reaction to inflation pressure.

Stanlib economist Kevin Lings says that inflation is an issue. He says that local interest rates have to go up more, up to 100 bps this year, as the SA Reserve Bank governor operates in the global economy.

As background he says that global inflation has drifted higher in the last 12 months. At the moment the world inflation is pegged at 2.7%. In a long term view this seems manageable.

The concern is the number of countries that have inflation targets New Zealand was first in 1990, and once the developed countries had done this the emerging markets followed the same route. SA introduced targets in 2000.

The world appears to keen on inflation targeting, especially the US Fed chairman who wrote a book on inflation targeting. The world is sensitive due to the targeting approach, and there is always an aggressive reaction.

Interest rate increases have jumped substantially, in some instances in percentage points the jump has been 50%.

On the other hand the oil price movements and shocks have had impacts on inflation rates too, but not as expected. Lings says that life has also changed and we now have a truly global economy. The current 300% leap in oil prices and it relatively small impact on inflation is evidence of this.

Lings maintains that the world is not at the top of the global interest rate cycles and the SA Reserve Bank can't view the local situation in isolation. Most recently Japan has hiked their rate from 0 to 0.25%. There is a very short list of countries that have cut interest rates, which does include the UK, although there are signs that they will hike rates soon.

This means that world growth will slow, says Lings. The USA portion will slow, while the governor there will still hike rates, just in case.

The effect on SA is that there is an effect on commodity prices, because there is less global demand. Commodity prices ran up far more than the leading indicators led investors to believe. There is some risk of volatility and reduction.

On the other hand China growth continues, regardless whether the growth is internal or externally focused. Added to which there is a shortage in commodities. A slow down won't affect the fundamentals, however.

There are four key issues that are concerning: The petrol price; food inflation; 53% of the CPI basket has inflation of less than 3%; and imported inflation.

Lings says that there is some short term pricing pressure and petrol will go up. The country won't be able to absorb petrol price increases as easily as before.

Food inflation at the consumer level is above the target and rising. Producer food inflation is coming under increasing pressure. There will be pressure on the processed food area. Food inflation is 20% of the CPI basket.

Thirdly half of the inflation index is 3% - this is a deflation number. The deflation will not persist. A small movement will drive inflation up.

Imported inflation is an issue. If the rand stays at the same levels for the next 10 months, and based on the charted the imported inflation will follow the rand and climb significantly.

It's not a crisis, if the country doesn't do anything. That is why the SARB hiked rates it was a pre-emptive strike. They had no choice. Interest rates will go up another 100bps, to keep inflation under control.

The risk if nothing is done means that there will be bigger rate hikes later.

The growth rate in SA will slow down from a high base. This will be a modest drop. Housing and passenger vehicle sales are prime indicators. It's a slow down off a high base it's manageable.

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