South African outlook on inflation and interest rates

A Great Article I just read from Arthur Kamp Investment Economist from Sanlam Investment Management.

Take heed from the message !!

Enjoy it !!

Regards

Steven


"On inflation and interest rates - A South African Outlook


Consumer Price Index (CPI) advanced 6.3 per cent in the year to January, before slowing to 6.1 per cent in February. Although the data is likely to be a choppy in the next few months, it does appear as though inflation is peaking and the next material shift in inflation is likely to be lower into next year. Indeed, headline CPI could dip below the upper end of the Reserve Bank’s inflation target range before the end of this year. Global maize and wheat prices have drifted lower over the past twelve months, the inflationary impact of the former Rand weakness should fade and the annual advance in petrol price inflation should also moderate into 2013.

If this proves to be the case it would call into question the Reuters consensus forecast for February 2012, which indicates a 50bp increase in the Reserve Bank’s repo rate a year from now from its current level of 5.5 per cent. The question is why would the SA Reserve Bank raise interest rates if inflation trends lower over the next 12 months?

One could argue caution is warranted because despite the expected slowdown in headline inflation, core inflation (headline CPI excluding food and fuel prices) is forecast to continue drifting higher through 2012. However, I expect core inflation to peak with a lag to headline CPI at around 5.5 per cent by 1Q2013. At the conclusion of its March Monetary Policy Committee Meeting the Reserve Bank published a similar core inflation forecast. Provided core inflation remains broadly in line with the expected outcome the Bank should not be unduly concerned.

Given the relatively benign inflation outlook and expected moderate growth in GDP of around 2.5 – 3.5 per cent this year and next, a forward looking central bank is unlikely to consider increasing its policy rate. Indeed, in such a scenario the Monetary Policy Committee is likely to leave its repo rate unchanged through 2012. After all, re-pricing of risk and the introduction of tighter lending standards by banks appear to be acting as a material break on many, although not all, categories of private sector credit extension.

In order to increase its repo rate, the Bank would need to argue the current low level of interest rates is not conducive to maintaining inflation stability in the long-run. However, it may be difficult to argue higher interest rates are required in an environment where unemployment at more than 20 per cent is similar to that of the United States during the Great Depression.

Admittedly, forecasts can be wrong. One risk for South Africa’s inflation outlook is a sharp depreciation of the Rand in the event of, say, a severe bout of global risk aversion should Europe’s debt problems escalate. South Africa is a small, open economy and the currency plays a key role in the inflation process. However, in this instance the Reserve Bank may not be concerned about a temporary bout of inflation induced by the currency’s fall. Rather, if an unwanted fiscal outcome in Europe is accompanied by a marked decline in global growth prospects, the Bank may be inclined to focus on weakening domestic demand prospects, which can be expected to constrain inflation.

The magnitude and timing of interest rate changes are becoming increasingly difficult to predict in an uncertain world. Current information suggests the Bank is unlikely to move in the next year or even longer if consensus forecasts for growth and inflation in 2012 and 2013 pan out.

Certainly, interest rates are very low compared with history and are likely to rise at some point in the future. But, we may need to wait for quite some time before that happens.

Written by Arthur Kamp, Investment Economist, Sanlam Investment Management "



Kind Regards


Steven



Steven Morris Chartered Accountant (SA)

Mobile :+27 83 943 1858
Facsimile : 0866 712 498
E-mail : steven@global.co.za