SARB ups by 0.5% as CPIX concern deepens

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By Cees Bruggemans

The SARB today announced another 0.5% increase in interest rates, with prime set to increase to 15%. This is the ninth such increase since mid-2006.

With CPIX inflation at 9.4% and still likely to rise further, pushed along by rising commodity prices (oil and food especially), a weaker rand (16% down this year) and looming electricity price shocks, the SARB is clearly perturbed about the changes in underlying inflation trends and their associated expectations.

Wage and salary increases averaged 7.8% in 1Q2008 according Andrew Levy Associates. The BER survey of inflation expectations indicates elevated ranges outside the target range for a long while yet.

As CPIX inflation moves higher outside the target range of 3%-6%, the danger is that businesses and the labour force will seek matching compensation, embedding such cost increases longer term, permanently moving the inflation rate higher.

Despite the inflation shock being primarily of an external nature, and therefore not easily contained, and despite spreading weakness in the economy due to tighter policy action, loss of purchasing power, lost output due to electricity interruption, and loss of nerve as confidence declines, the SARB is firmly sticking to the mission given it by the government.

That mission is to influence how people think about inflation and their demands as inflation rises. Thus the SARB remains willing to offer countervailing pressure even as rising inflation and the compensating demands it brings in its wake cannot be addressed directly.

This further increase in interest rates is likely to lead to a further slowing in consumer spending, and probably also to more slowing in certain areas of private fixed investment spending. On the other hand, one should allow that agriculture is experiencing a windfall, that high commodity prices are benefiting the mining sector, and that many producers benefit from the weaker rand, thereby supporting income growth.

GDP growth, which averaged near 5.5% last year, is likely to be closer to 3% in 2008-2009.

As to what lies ahead for inflation and interest rates, this is as yet unclear. Commodity prices continue to be elevated, and Eskom tariff requests, if successful, are bound to lead to a double-digit CPIX inflation peak later this year, with probably only a slow descent thereafter through 2010.

As inflation expectations will probably take time being contained, it remains to be seen how the SARB is prepared to react in coming months as inflation explores even higher levels than seen so far.

The proof, apparently, has to come from underlying domestic inflation pressures and expressed expectations. That means wage settlements, inflation surveys, bond yields, company pricing decisions. But we also need to see a peaking of the commodity-driven price spiking, as this is the main driver behind rising inflation expectations.

As indicated by Governor Mboweni, these are tough times. Indeed, tougher times may lie ahead.

Source: Cees Bruggemans, Chief Economist, FNB, April 10, 2008.


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