Our changing inflation outlook

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By Cees Bruggemans

For two years there has been no let up in our inflation outlook, as CPIX bottomed at 3.5% in 2006, since then rising to 11%, with peak talk of 13% shortly.

Two occurrences will importantly shape our inflation next year for the better. But it is what we as yet don’t know about 2009 events that will be most crucial.

Firstly our agricultural windfall this year is delivering a 12 million ton maize harvest. This is acting like a shield against global agricultural price pressures, behind which our domestic food prices can proceed more moderately than otherwise would have happened.

Our agricultural commodity prices in Rand terms started moderating earlier this year under the influence of the record harvests shaping.

Whereas the agricultural price shock of 2007 is still entering our inflation indices as it progresses up the value chain into processed manufactured foods, global events in 2008 do not so far appear to be influencing our domestic food prices unduly.

The same may be hoped for 2009, with large increased carryover stocks of maize keeping a lid on domestic prices even if prices were still rising abroad.

If such good news could be maintained, the year-on-year food price inflation next year could subside. The long-awaited unwinding of the first-round food price shock would finally be upon us. Prices wouldn’t have to fall to achieve this, but merely move sideways for a year, implying that year-on-year inflation would drop heavily.

Last week StatsSA announced the weights it will be using in CPIX inflation calculation from 2009. Food, petrol, electricity and health will lose heavily in weight, as compared to alcohol, transport and miscellaneous gaining.

These index changes are legitimate, reflecting estimated changes in South African consumption baskets over time.

The net result will lower CPIX inflation by 1.5% compared to what it otherwise would have been from 2009 onward.

If the projection was for a CPIX inflation of 13% in January 2009, this will now drop to 11.5% due to these weight changes in computing CPIX inflation next year.

It is a pity StatsSA couldn’t have made this change earlier. For May 2008 CPIX inflation wouldn’t have been 11% but 9.5%.

As a consequence, labour demands would have been less overstated. The civil service agreed last year to a multiyear wage agreement of CPIX plus 1%. They are about to get 11%+1% basic increase, plus notches plus benefits. The public sector as largest employer in the economy provides a major benchmark to private sector employers as well. We are baking into the wage cake at least 1.5% too much inflation compensation that shouldn’t have been there at all this year.

Relevance for monetary policy is important, with the SARB so-called fighting second-round inflation effects it in any case can’t prevent, but raising interest rates with an overstated inflation benchmark in mind.

But if that is the bad news, could the good news be it will all unwind that much quicker in 2009, in turn triggering relief from the SARB as well?

If food prices can evolve more benignly, along with the CPIX weight changes, this should contribute to a rapid falloff in CPIX inflation in 2009.

But that would still leave us with a few other headaches.

Firstly there is the 2008 second-round effects as wage increases top 10% and larger businesses come into the habit of passing on their cost increases.

Secondly, oil. Will it halve, double or do the splits?

Thirdly, the Rand, never a stable proposition. It is currently supported by high interest rates and copious foreign borrowing to fund the large current account deficit. What changes will we still encounter globally, and how will this play through to the Rand?

Fourthly, world inflation is rising, pushing up our import costs. This hasn’t been much of a factor in recent years but may cease to be marginal in coming years.

So, yes, the CPIX outlook on a two-year view looks encouraging, as it has for the past two years. And, yes, we continue to face potential inflation rogues, mainly oil and the Rand, also like the past two years.

Will 2009 finally prove to be the year in which we get lucky, and the great unwind can begin?

Global central bankers have certainly shifted gears, accepting growth sacrifice as they raise interest rates.

Global growth should slow, and commodity price inflation should peak. We just don’t know how much of a final inflation push may still materialize, especially in oil, that may shape a much more modest global growth environment in 2009-2010.

Cyclically, we may be three-quarters there. But the last bit of the journey may prove most tumultuous, thinking oil and Rand.

Thank goodness for the food shield and impending weight changes. Without them our CPIX situation in 2009 would be a lot direr.

Source: Cees Bruggemans, FNB, July 7, 2008.

 

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