90% of FAnews online readers agree with Moody's

Over the course of this week, FAnews online asked readers whether they believed that the June interest rate hike would be the last for the year. The bad news is that more than 90% of readers polled felt that Reserve Bank governor Tito Mboweni had more in

This view was confirmed yesterday by one of the most respected financial ratings agencies in the world. Kristin Lindow, vice-president in the Sovereign Risk Unit at Moody's Investors Service believes that the Reserve Bank governor will have to raise rates again. Lindow says the hike could happen as early as the next Monetary Policy Committee meeting in August 2007.

FAnews online has dedicated quite a few of its recent newsletters and articles to the topics of inflation and interest rates. The reason for this is the state of the economy impacts on every sphere of business. When consumers are strapped for cash, they tend to discard those purchases which they view as non-essential. And often the financial services industry is in the first line of fire when it comes to discarding services.

Unravelling the mystery of how inflation was held in check for so long

Lindow expresses surprise at how well the South African economy had withstood inflationary pressures in the last year. "One surprising thing is the economy has been able to absorb increases in the oil price it has a lot to do with economic management. But SA is now facing the situation where inflation is somewhat of a worry."

Readers will have felt the full impact of a spiralling global oil price. While the economy seems to have weathered the storm, we have felt the full impact of a series of petrol price increases. Right now, the Gauteng price of 93 Unleaded is at a record high of 711 cents per litre. The continued upward move in fuel prices has also resulted in accelerations in the price of foods and other transported consumer goods.

Despite the series of interest rates in 2006 and the latest half percent increase, Lindow believes that underlying inflation concerns still exist. She believed that "CPI and PPI were higher than the market expected, especially PPI at 11%."
 
The inflation interest rate cycle

Controlling inflation is a very difficult task. One of the major problems is that changes to economic variables can only be measured months down the line. An array of non-related economic trends and events can impact negatively on this measurement.

For example, South Africa's much talked about credit spending problem could in part be warranted by unexpected improvements in employment numbers. Thus the Reserve Bank's concerns about the higher spending could be overdone.

Lindow believes that "monetary policy is in a tightening phase and higher inflation could continue longer than SARB expected a year ago.' The Reserve Bank believes that interest rates remain the best device to keep inflation in check. Some argue that using interest rates against inflation is a counter productive strategy. They say that the practice of raising interest rates can in itself cause additional inflationary pressure a bit like throwing fuel on a fire!

Another major concern for the South African economic outlook is the current account deficit. In simple terms, this deficit refers to the amount that South Africa spends on imports in excess of the amount earned from exports. While South Africa has miles to go before reaching a current account deficit as large as the US's, Lindow believes the trade deficit will persist for some time. The reason is that spending in South Africa is "moving from consumer goods to investment goods." This will result in the current account deficit trending slightly higher going forward.

Time to look for opportunities to cut household expenses

A 2% increase in interest rates has a massive financial impact. Even a reasonably small (by today's standard) bond of R800 000 taken over 20 years will attract monthly repayment increases in the order of R1 139 in such circumstances. This amount sounds manageable, but when you consider the required before-tax increase in gross monthly income to cover this amount, the true impact of the rate hikes hit home.

South African families will have to start investigating alternatives to help reduce monthly expenditure. Failure to do this could result in debt spiralling out of control. It is better to be pro-active in managing expenses, rather than sitting back and waiting for someone else to suggest ways of solving the problem.

Perhaps the average consumer will have to cut out a few trips to restaurants, cancel the satellite television contract and reduce unnecessary trips in coming months. Should more rate hikes occur, a real danger exists that consumers will start looking at reducing contributions to retirement savings and other insurance produces, which while important are often incorrectly viewed by consumers as non-essential purchases.

Editor's thoughts:
The South African Reserve Bank has long had a policy of targeting the 3% to 6% inflation band. The most recent statistics show CPI moving through the upper range of this band. There are some who believe the CPI number is grossly understating price inflation in the market for consumer goods especially food. Based on your consumption experiences, what would you estimate food price inflation to be at the moment? Send your comments to gareth@fanews.co.za.