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The inflation tug-of-war: Oil & food versus the rand

07 November 2008 Gareth Stokes

Forecasting is a mugs game. Regardless of the breadth of macroeconomic data the economists feed into their forecasting models they’re always a few steps behind the game. You only need to compare analysts’ forecasts with actual numbers to confirm this fact

Despite the proven inaccuracy of these forecasts economists cannot satisfy the demand for them. Every minute of every day they are hounded by the press and in-house investment teams for 12-month forecasts on inflation, interest rates and exchange rates in particular. People want to know whether to sell their foreign currency today – or hang on to it and achieve a better rate three months from now. And everyone wants to know whether the All Share Index will be higher or lower next year – and by how much. FAnews is no different. At a recent Metropolitan Asset Managers (MetAM) media day we joined throngs of other journalists in their quest to predict the future by listening to economic analyst Jaanre Fourie’s presentation on “The Changing Inflationary Environment.”

What’s behind the upward inflation spiral?

Inflation has been on a tear for the last four years. In April 2004 CPI stood at an inconsequential 0.2%, a fraction of the 13.5% measured in September 2008. Over a similar period CPIX (a measure of inflation adjusted to exclude the impact of mortgage repayments) jumped from 3.11% to an August 2008 high of 13.6%. A great deal has been written about inflation and techniques to combat it. We know that the SA Reserve Bank follows a disciplined inflation targeting policy, hiking interest rates repeatedly to try and ‘cool’ money demand and prices. But we also know that a big slice of the inflationary pressures experienced in our country of late have global roots.

South Africa was caught up in an inflation spiral led by higher international food and fuel prices. Not so long ago we reported on riots in developing economies due to staple foods like rice and maize becoming unaffordable. And it’s impossible to forget the price carnage in the wake of oil’s rise to more than $140 per barrel. As oil climbed local motorists had to absorb more than eight consecutive fuel price increases… Fourie notes that fuel and food remain the main drivers in the domestic inflation number. In October food price inflation came in at 17.9% and transport at 18.4%. Strip these categories out of the mix and CPIX is a more manageable 8.6%. But food and fuel are largely spent forces...

Fourie notes that we might have seen the peak in food price inflation in August while transport appears to have peaked in July as oil prices cooled. Agricultural commodities have dropped significantly with white and yellow maize futures approximately 30% below the peak. International food prices are also on the decline… And oil has blown its proverbial gasket. Nine months ago anyone who suggested $60 per barrel oil would have been locked up in an asylum. Today that price is not only a reality; but there are those who think it could go even lower.

Oil’s decline is not good news

Although we welcome lower food and oil prices, the slide in oil in recent times is not all good news. Lower demand for the fossil fuel is indicative of a serious decline in global economic activity. And you only need to look at the motor industry to see how serious the economic crunch is becoming. We already know that domestic passenger vehicle sales are down some 30% for the first three quarters of 2008. The trend is even more severe in the world’s developed economies. Toyota, the world’s largest car maker, reported a 69% decline in operating profit for Q3 2008 stating that the current market conditions were the toughest in recent memory. And rival manufacturer BMW recently announced it wouldn’t be able to forecast profits for coming quarters. Car sales in the entire US market were down 30% month-on-month in October.

As soon as heavy industry struggles, the demand for crude oil falls. Thus the fall from $140 to $60, while welcomed by consumers around the globe, is actually a giant warning sign screaming RECESSION. And that’s why oil dropped another 7% after the US election. The commodity wasn’t only reacting to the news that stockpiles of fuel in that country were at record levels; but based on expectations of a long drawn out recession.

Will 2009 slay the inflation dragon?

The team at MetAM believe that inflation will drop faster than anyone expects in the New Year. Their baseline forecast is for an average of 11.4% in 2008 and an average of 6.9% in 2009. The 2009 forecast is based on aggressive predictions for the rand dollar exchange rate (to average at R9.50/$) and the per barrel price of oil (an average $70). But changes in long-term trends could throw these forecasts on their heads. There is a risk that oil veers either side of the estimated $70 per barrel, or that the rand veers wildly from the R9.50 per dollar scenario. In each case, Fourie notes, the risk could go either way. If the swing is favourable for the domestic economy – oil falls or the rand strengthens – then we could see further downward pressure on the inflation number.

And the question on everyone’s lips: When will we see interest rate cuts? South Africa is not yet in the same position as countries like the US and UK. We’re not at risk of deflation like these economies are… But under the scenario painted in this article we’ll certainly see aggressive cuts from mid-2009. Some analysts say we could see a quick 400 basis point reversal; but we’ll be more conservative and hope for a 2% to 3% reduction by year end 2009.

Editor’s thoughts:
Consumers have endured a torrid 2008. While the prices of goods and services have been rising, assets such as equities and houses have been losing value like there’s no tomorrow. A reduction in inflation and interest rates is long overdue. Do you think Mboweni will cut interest rates next year – and if so by how much? Add your comments below, or send them to


Added by Gideon Raath, 12 Nov 2008
to be honest i do not trust you source or any other person trying to predict what is going to happen. Not one of them predicted what happened in 2008 timeously. nobody predicted that oil would fall that far. facts we are in for a tough time and we have to keep debt levels as low as possible even if the ecomomy turns properly. do not spend right away because if interest rates are lowered next month and inflation falls and you bettered your debt to income ratio you will be the wisest investor of them all!! then you can make use of every opportunity that presents itself. Good luck!!
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