Change of target
Government’s new CPI to exchange mortgage costs for rentals
FINANCE MINISTER TREVOR MANUEL might change the targeted measure of inflation from CPIX to CPI next year. The reason is that the way in which CPI is calculated will be changed to give a more accurate measure of total inflation than CPIX. The change, should it occur, would have major implications for monetary policy as the CPI rate won’t fall as sharply as CPIX would have done. That’s something that hasn’t been taken into consideration by inflation bulls, such as Investec Asset Management’s André Roux and John Stopford.
The SA Reserve Bank’s targeted measure of inflation is called the CPIX rate because it’s the rate of change in the consumer price index (CPI) excluding the cost of mortgages. The cost of mortgages – determined by interest rates – was excluded in the Bank’s targeting exercise as interest rates are used as a weapon against inflation and it wouldn’t make any sense at all to have inflation rise when the weapon is used.
However, from next year – when Statistics SA undertakes its revamp of SA’s inflation figures – CPIX will effectively cease to exist. The reason is that Stats SA will no longer use the cost of mortgages as part of its measure of housing costs in the CPI. Instead, it will use rentals of equivalent dwellings. Stats SA says a survey of rentals initiated by it in 2005 will form the data source for “owners’ equivalent rent” – the new approach to the cost of housing in inflation.
Stats SA says homeowners incur two types of costs: the capital cost, which creates a fully owned asset at the end of the mortgage period. That isn’t a component of the current cost of living. The second cost is the cost of consuming a housing service. “This is the opportunity cost caused by an owner who chooses to live in his home rather than rent it out. It’s this cost that is referred to as owners’ equivalent rent.”
In the survey that Stats SA will conduct to determine owners’ equivalent rent, real estate agents will be the respondents. A
Monetary policy will be affected by
sample of actual rental properties is selected from the books of a letting agency. The amount paid in rent for those properties is recorded each quarter for as long as the property is available for rent. Additional charges included in the rental are also recorded to facilitate the tracking of a pure rental.
In the old CPI, the rentals sample is equally distributed over the three major housing types. In the new CPI its composition will be adjusted so it represents the fact that houses account for the vast majority of owner occupied accommodation and flats and townhouses for a small share. In fourth quarter 2007 and first quarter this year 4 601 and 4 303 observations were recorded respectively. But Stats SA intends to increase its sample size to between 8 000 and 10 000 dwellings over the course of 2008.
What does the change mean for SA’s inflation rate? Rand Merchant Bank economist Ettienne le Roux calculates there will still be a step down in the rate once the new weightings and rebasing are put in place in January 2009. But the CPI rate will be higher than the CPIX rate. Le Roux expects the CPI rate to peak at 13,8% in July this year, dipping to 9,5% in January next year and gradually moderating thereafter. His estimates of average CPI inflation are 11,7% in 2008, 8,1% in 2009 and 6,2% in 2010. The 8,1% average for 2009 compares with a CPIX average of 7,1% for the same year.
Investec Asset Management’s (IAM) forecasts for the CPIX rate for next year were very bullish. IAM head of fixed income André Roux says his team didn’t take into account the possibility Government might move to a CPI target next year instead of retaining CPIX.
Manuel’s office, approached for comment, says: “Imputed rent and mortgage interest costs are different things. The former is the opportunity cost of renting a property to an owner or the cost of renting. The lat- ter is the cost of borrowing for housing. The new CPI doesn’t include mortgage interest costs. Any announcement of a change in the inflation target price index will occur at the time of the medium-term Budget policy statement (MTBPS).”
The MTBPS usually occurs in October. The question now becomes how the Reserve Bank will conduct its inflation forecasts without any official notification of a change and in the knowledge that CPIX will effectively fall away from next year. Hopefully, some clarification will emerge when the Bank makes its next monetary policy statement on 14 August.
Didn’t take into account a possible change in the target. André Roux Announcement will only come in October. Trevor Manuel