Optimism may be overdone
Disagreement on timing of interest rate cuts
INVESTEC ASSET MANAGEMENT’S release of dramatically improved inflation forecasts for South Africa has had a profound effect on the markets. The forward rate agreement (FRA) market – which shows expected future interest rates – is pricing in only a 20% chance of an interest rate hike in August and is now pricing in 150 basis points in interest rate cuts next year.
Investec based its forecasts on the fact that Statistics SA is re-weighting the goods that make up the CPIX basket and is also rebasing the base year to 2008. One question that arises is whether Investec is too optimistic in its inflation forecasts. Another is the timing of the next cut in interest rates.
Investec Asset Management head of fixed income André Roux says he expects inflation to fall into the target band by mid-2009 and to be at the mid-point of the band by year-end, with some uncertainty depending on how the oil price behaves. That’s a very bullish outlook indeed. If correct, it should give the SA Reserve Bank scope to start cutting interest rates early.
However, others are less convinced. Rand Merchant Bank (RMB) economist Ettienne le Roux, while agreeing there will be a significant step-change downwards in the CPIX rate early next year, is less optimistic about the timing of inflation entering the target range. He says he expects CPIX inflation to peak at 13,2% in July, dipping sharply to 8,6% in January 2009 and moderating to 6,3% in December 2009. Inflation will only enter the target in 2010.
RMB expects average CPIX inflation of 7,1% in 2009 and 5,6% in 2010. Le Roux expects four basis points of interest rate cuts over the next two years, with the first taking place in June 2009. Le Roux notes the recent drop in the oil price, the fall in the maize price and the strengthening of the rand have improved the short-term outlook for inflation. He no longer expects Reserve Bank Governor Tito Mboweni to hike interest rates in August.
An important point about the new inflation basket is that about a quarter will consist of items that haven’t been included before. Examples are minibus taxi fares, funeral costs and funeral insurance, Internet service provider fees and laptops. Any forecasts of inflation for next year would have to contain a “guesstimate” as to the behaviour of those prices. Statistics SA began collecting those prices this year so that comparisons are possible from next year.
Also important to note is the fact that the number of products in the CPI basket will fall from 1 124 to 416. However, the same overall number of prices (around 100 000) will be collected, which Le Roux says means the accuracy of the prices collected will improve.
Standard Bank economist Danelee van Dyk also expects inflation to average around 7% next year. She believes inflation will enter the target range next year but will be outside of the target range again in 2010.
She points out that services inflation – which includes items such as medical costs and education – will have a greater bearing on inflation from next year, given the increase in its weight to 38,3% from 33,8% previously. “Services inflation is sticky. This component only recently pierced the target, and will also be slow to come back down below the target again,” she says. Van Dyk expects the first cut in interest rates only to take place in August next year.
Efficient Group economists Fanie Joubert and Doret Els say the very fact that food and fuel will have a lower weighting in the inflation basket from next year will prevent inflation from falling dramatically during 2009. They say the “base effects” and high weighting of those categories would have led to inflation subsiding in 2009. (“Base effects” occur when increases slow down and are calculated off a high base in the preceding year.)
“That base effect will now be smaller in the new basket, causing inflation possibly not to decelerate at the same rate as previously estimated. In addition, the second-round effects of the spike in food and fuel prices are set to continue to come through and so the other categories in the inflation basket might see higher price rises next year. Therefore, the assumption that the inflation picture will improve dramatically under the new weighting system must be made with great care,” Els and Joubert say. Nevertheless, they see the first interest rate cut in June next year.
Absa and Nedbank are the most bullish on the timing of interest rate cuts, saying the first should take place in first half 2009.
Inflation will be 6,3% by December 2009. Ettienne le Roux