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South Africa: More Rate Hikes for This Year 'Unlikely'

Mariam Isa

28 August 2008

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Johannesburg — INFLATION is still set to scale new peaks over the next couple of months, but the benign long-term outlook means that further interest rate hikes are unlikely this year.

News yesterday that the yearly rise in CPIX surged to 13% last month from 11,6% in June -- not far out of line with forecasts -- prompted a rally in government bonds.

Markets are now pricing in a total of two percentage points of cuts in lending rates over the course of next year, although that may be a bit too optimistic.

There are still a number of risks to the inflation outlook, which include volatility in the rand and oil prices along with steep local wage settlements.

There is also a big question mark over the effect of changes to the way in which consumer prices are calculated, which may lower inflation by two percentage points early next year.

Finance Minister Trevor Manuel has signalled that CPIX, which excludes mortgage costs, will be replaced by the main consumer price index next year.

That move makes sense as home loans will be replaced by a new data series -- "owner equivalent rent" within headline CPI.

But the annual rise in this measure has exceeded its equivalent in CPIX for the past couple of years, so it may take longer for inflation to return to its 3%- 6% official target range.

Yesterday's figures from Statistics SA showed that CPI rose by an annual rate of 13,4% last month, from 12,2% in June.

"Even with the release of further shock inflation data, it seems improbable that the Reserve Bank will decide to tighten further," said Razia Khan, Standard Chartered's research head for Africa.

"But ... inflation expectations do need to be watched, and they will continue to pose an upside risk to inflation in the months ahead. SA is clearly not out of the woods yet," she said.

The Bureau for Economic Research is due to release its next quarterly inflation expectations survey at the Bank's next policy meeting in October.

That could actually tip the scale towards another 50 basis point rate hike, which is the outcome which Lehman Brothers emerging markets economist Peter Attard Montalto expects.

Goldman Sachs economist Ashok Bhundia is also worried, mainly about the huge deficit on SA's current account, its broadest measure of trade.

"Any pressure this brings to bear on the rand would slow down the rate of decline in inflation we forecast for next year, and could bring the rate cutting cycle anticipated in 2009 to an abrupt end," he said.

Weakness in the currency tends to fan inflation by making imports more expensive, and the unit has depreciated more than 11% so far this year.

Nonetheless, Bhundia still expects the Reserve Bank to cut its key repo rate by one-and-a- half percentage points next year, taking it down to 10,5%. It all depends on what happens to the medium-term inflation outlook, which is 18 months to two years from now.

Standard Bank believes that CPIX will peak at 13,5% next month, while African Harvest's Adenaan Hardien predicts that it will scale 14% in October.

"Even with a sharp decline in inflation thereafter ... we expect CPIX to only fall within the target at the end of next year or in the first quarter of 2010," he said. "While this would suggest scope for interest rates to start declining from mid-2009, it is certainly not a done deal."

Many analysts think that CPI and CPIX will converge next year, with both inflation measures returning to the official target range before 2010.

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