SA inflation down by more than expected

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By Kevin Lings

In December 2008, headline CPI inflation fell sharply to 9.5%y/y from 11.8%y/y in November. This was better than market expectations for a fall to 10.0%. CPIX inflation also fell sharply, dropping by 0.9%m/m in December, with the annual rate falling to 10.3%y/y, from 12.1%y/y in November. This was also below expectations for a fall to 10.6%y/y. (Stanlib 10.8%y/y). This is the 21st consecutive month that CPIX inflation has been above the target range of 3% to 6%.

The main reason for the sharp drop in CPIX inflation during December was, once-again, the decline in the petrol price. The so-called base effects also had a favourable impact on the annual rate of change.

During December, food prices (within CPIX) rose by 0.7%m/m, adding 0.2 percentage points to the monthly increase in CPIX. The monthly increase was actually less than we had anticipated, and was concentrated in fruits (4.2%m/m), vegetables, (3.3%y/y), and meat (1.0%m/m). Fortunately the price of sugar declined during the month, (-2.0%m/m). Overall CPIX food inflation is now down at 16.8%y/y, and is benefiting from the high base effect that was established during 2008; although it is proving to be relatively sticky on the upside considering that agricultural inflation is in deflation. As we indicated some time ago, the August 2008 food inflation reading of 19.2%y/y should prove to have been the peak, and we expect consumer food inflation to continue to moderate during the course of 2009.

Encouragingly, international food prices have fallen noticeably in the past few months; however the full benefit of this is mitigated by the sharp fall in the exchange rate and the desire by SA food producers to re-coup operating margins that were lost when agricultural prices initially started to escalate (see chart attached).

Vehicle running costs declined by a very welcome 12.6%m/m in December, reflecting mostly the R1.61c/l price reduction in December. The annual rate of inflation for vehicle running costs is now a very acceptable and modest 1.3%y/y, which is down from 36%y/y in July 2008. Fortunately, there was a further substantial petrol price decrease of around R1.30c/l in January, which will help to reduce the January inflation rate. Recent currency weakness, coupled with some increase in the oil prices will unfortunately lead to a petrol price hike of around 50c/l in February.

One of the key factors that will still concern the Reserve Bank going into the February interest rate meeting is the fact that CPIX, excluding food and fuel, is still very high at 8.6%y/y. This is mainly because some inflation categories, including administered prices, remain well above the target range. These include beverages (+10.9%y/y), clothing (+16.6%y/y), electricity (27.7%y/y), and education (8.3%y/y), However, while this underlying measure of inflation has generally moved higher in the past 6 months, it appears to have started to level out, and by our estimation has peaked.

Looking forward, it is very clear that CPIX inflation peaked at 13.6%y/y in August 2008, and should continue to fall-off very sharply over the coming months. This disinflation effect should be helped by a combination of the lower petrol price in January, the re-weighting of the inflation basket in January, and the high base effect that has been established in a couple of key inflation categories during 2008; the most notable of which is food inflation. The significant slump in domestic and international economic activity should also work to keep inflation subdued.

Unfortunately, the sharp weakness in the exchange rate (which declined by around 28% against the Dollar in 2008) will offset some of this benefit.

On balance we expect CPIX inflation to move back into the target range during Q2 2008. This combined with the weakness in the economy and slowing credit demand should allow the Reserve Bank to continue to cut interest rates. We currently expect the Bank to cut rates by at least 50bps at each MPC meeting this year. However, there is now clearly a window of opportunity for the Bank to be more aggressive in cutting rates; and a reduction of 100bps is certainly very feasible at the February MPC meeting.










Source: Kevin Lings, Stanlib, January 29, 2009.


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