SA Inflation – another shock
By Kevin Lings
In April 2008, headline CPI inflation rose by a very substantial 1.8% m/m, with the annual rate rising to 11.1% y/y from 10.6% y/y in March. This was much higher than market expectations of a rise to 10.8%. CPIX inflation also rose by a significant 1.6% m/m in April, with the annual rate increasing to 10.4% y/y, from 10.1% y/y in March. This was well above expectations of an easing to 10.0% y/y. This is the 13th consecutive month in which CPIX inflation has been above the target range of 3% to 6% and the highest level of CPIX inflation since December 2002.
The main reason for the increase in CPIX during April was again food and transport costs, while domestic worker wages rose by 6.3% in the month, taking the annual rate up to 13.4% y/y. Together these three factors accounted for 1.5 percentage points of the 1.6% m/m increase. There is a very clear risk that the longer CPIX stays above the target, inflation expectations and wages will be impacted negatively. Already some wage demands are being settled above 10%, while the average wage increase is probably moving closer to 8.5%. In addition, a breakdown of CPIX by income group shows that for very low income earners (as defined by Stats SA) inflation is now at 13.8%! The main reason is that food alone accounts for 51% of the basket! This could manifest in protests about the high food price, as well as much higher wages demand.
During April, food prices (within CPIX) rose by a massive 1.5% m/m, adding 0.5 percentage points to the monthly increase in CPIX. The increase was broad-based and included sizeable increases in fats and oils (7.5% m/m), fish (2.1% m/m), sugar (+1.9% m/m), grains (+1.6% m/m) and meat (+1.0% m/m). Overall food inflation is now at 15.9% y/y. While international food prices have moderated a little in the past month, and SA’s maize crop is likely to be 50% bigger this year compared with last year, there is still significant upward pressure on domestic prices at both the producer and consumer level. Theo, who is hugely experienced and covers the food producers very closely, believes this pressure could persist for the remainder of 2008 and into 2009. Consequently, I have once again revised the forecast for the next 12 months upwards by food inflation. This has a very material impact on the inflation forecast! (See graph attached.)
Vehicle running costs rose by 6.1% m/m, which reflects mostly the 66c/l increase in the petrol price in April. The annual rate of increase in vehicle running costs is now 25.3% y/y. This contributed 0.6 percentage points to the monthly increase in inflation in April, and was obviously expected given the prior knowledge of fuel price changes. Unfortunately, a further price increase of 55c/l occurred in May, while an additional hike of about 35c/l is expected in June.
Domestic worker wages rose by a somewhat unexpected 6.3% m/m in April and by 13.4% y/y. This increase had been delayed from earlier months and is based on the Labour Force Survey. While we had expected an increase, we had not anticipated this large an increase, which added 0.4 percentage points to the monthly rise in CPIX inflation.
As mentioned last month, in the midst of all these extreme price increase medical inflation still stands out as one of the only key categories of consumer inflation still below 6%. Currently medical inflation is measured at 5.6% y/y. While this is positive for inflation, it raises concerns about the ability of the private health-care system to continue to supply world-class treatment as well as expand operations.
Looking forward, CPIX inflation is expected to remain at around current levels for much of this year. This is not only due to the current cost pressures in the system but also due to the impending increase in electricity prices. Eskom is arguing for a 53% increase in electricity tariffs in June, which is much higher than the initial agreement for a 12.4% increase. Without going into the details of the debate, it does seem likely that electricity tariffs will at least double over the next two or three years. Consequently, we have built in a 30% increase in electricity tariffs for both this year and next. The effect of this is to keep CPIX inflation in a range of 8.5% to 10.5% for all of this year, and well above the target for all of next year. The decision on the electricity tariff adjustment was initially scheduled for 6 June, but unfortunately this has been postponed to 18 June. Crucially, this is after the 12 June MPC interest rate decision, which means the Reserve Bank is unlikely to have full information on this critical issue prior to making its decision.
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% but is now forecast to average 10.5% in 2008. Importantly, CPIX inflation is expected to remain elevated over the coming two years 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, while the latest GDP growth estimate is heavily impacted by the electricity outages in Q1 2008, which should partly rebound in Q2 2008, the outlook for the next few quarters points to growing evidence that the broader economy is slowing. This is evident in the relationship between the leading indicator and GDP growth. Motor vehicle, and furniture sales have already turned negative on an annual basis. Cement sales and building plans have also moderated considerably, while manufacturing production is slowing. We have revised our 2008 growth rate down to 2.7%, from 3.2% anticipated a few months ago and 4.0% anticipated in the middle of 2007. These revisions are due to the unexpected increase in interest rates in February, the likely further hike in rates in June, the damaging impact of the electricity outages, and further evidence that the consumer is under significant cash-flow pressure. On the plus side, the agricultural season is surprising on the upside. For example, we had originally forecast a 30% increase in maize production during 2008, but this is more likely to be around 50%. Construction activity is holding up well given the large infrastructure projects and, in addition, the government sector is slowly making a larger contribution to growth.
From an interest rate perspective, the Reserve Bank is likely to continue to argue that although the economy has been responding to the previous increases in interest rates, inflation expectations have increased significantly and are no longer clearly anchored within the inflation target range. In addition, the likelihood of substantial electricity price increases poses an additional risk to the inflation outlook. Consequently, I would unfortunately expect the Reserve Bank to hike rates by a further 50bps on 12 June. This would take the prime interest rate up to 15.5%. Hopefully that will prove to be the top of the interest rate cycle.
Source: Kevin Lings, Stanlib, May 28, 2008.
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