SA inflation approaching turning point

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By Kevin Lings

In February 2008 headline CPI inflation rose by a modest 0.3% m/m, with the annual rate rising to 9.8% y/y from 9.3% y/y in January. This was in line with market expectations. CPIX inflation rose by 0.4% m/m in February, with the annual rate increasing to 9.4% y/y, from 8.8% y/y in January. This was also in line with expectations. This is the eleventh consecutive month that CPIX inflation has been above the target range of 3% to 6% and the highest level of CPIX inflation since January 2003.

The main reason for the increase in CPIX during February was again food and transport costs. Together these two factors accounted for 0.3 percentage points of the 0.4% m/m increase. Although we expect CPIX inflation to moderate during 2008.

During February, food prices (within CPIX) rose by 0.6% m/m, adding 0.2 percentage points to the monthly increase in CPIX. The increase was relatively broad-based and included sizeable increases in grains (+3.7% m/m), fats and oils (+3.4% m/m) and fruits (+1.8% m/m). Fortunately, meat prices fell by 1.3% m/m, while vegetable and sugar prices declined by 1.1% m/m and 0.6% m/m respectively. Overall food inflation at both the producer and consumer level remains under severe pressure due to a range of domestic and international factors. Shockingly, in rand terms, at the end of February international food prices were up a staggering 67% y/y. This could clearly lead to further upward pressure on SA food prices in the short term.

CPIX inflation is expected to remain at around current levels in March, reflecting the large petrol price increase of over 60c/l, as well as base effects. CPIX inflation should then slowly start to moderate, but is unlikely to reach the upper end of the target range by the end of 2008. The recent larger-than-expected increase in international food inflation remains the most immediate concern, while the upward drift in services inflation (now at 6.0% y/y) is also a growing concern given the upward price pressure from institutions such as Eskom! It is also worth noting that CPIX excluding food has broken through the upper end of the target range for the 3rd month since 2003!

For 2006 as a whole CPIX averaged 4.6% y/y, up from 3.9% in 2005 and 4.3% in 2004. For 2007 as a whole CPIX averaged 6.5% and is forecast to average 8.0% in 2008. Importantly, CPIX inflation is expected to remain elevated over the coming year and seems unlikely to fall back into the target range for some time unless there is a very significant moderation in food inflation (see forecast attached).

In terms of the real economy, consumer spending on general merchandise (especially furniture and appliances), motor vehicles and housing activity have all clearly slowed in the face of higher interest rates. Furthermore consumer spending is likely to continue to moderate in the months ahead. Consequently, pushing interest rates higher at this stage runs the risk of severely harming the consumer at a critical time, without substantially bringing down CPIX inflation. While the Reserve Bank needs to contain inflationary pressure and inflation expectations, it also needs to guard against undue excessive tightening of liquidity conditions that could lead to a consumer recession and increased bad debts and financial turmoil.

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Source: Kevin Lings, Stanlib, March 26, 2008.

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