Op­ti­mism may be over­done

Dis­agree­ment on tim­ing of in­ter­est rate cuts

Finweek English Edition - - Economic Trends & Analysis - GRETA STEYN gre­tas@fin­week.co.za

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

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