By Cees Bruggemans
A month ago, with CPI inflation at 8% and with a CPI forecast of 5% for 2010, and noting a large output gap (economy in recession now and only slowly recovering next year), the SARB was willing to go on hold with interest rate easing, bearing in mind the risks of the inflation forecast turning out to be wrong (bias to upside).
Now a month later, have interest rate prospects in any way changed?
CPI inflation is now at 6.9% (for which we say much thanks), with the forecast for 2010 remaining at 5%, with no change to the large output gap (recession still to end), and only a slow recovery expected next year.
In effect, therefore, nothing has changed to the main fundamentals governing the interest rate decision, before examining the risks of the inflation forecast turning out wrong (bias to upside or downside).
As to these risks, labour unions have been waging a shrill campaign for outsized wage settlements approaching 15% in the public sector and the most unionized parts of the private sector, in a year (2009) in which CPI inflation will average 7%, and looking forward to 5% CPI in 2010.
This, to put it mildly, increases upside risk to the main inflation scenario for the next 12 months from a cost-push point of view.
Meanwhile, previous SARB doubts regarding high future administered price increases and sticky services inflation probably remain unchanged.
Good news is that oil prices may not surge as much as previously expected, given the likely evolution of the global demand/supply balance, targeting $50-$70 next 18 months. Also, Rand firmness in 7-8:$ range is a high probability.
Also heartening is the latest PPI inflation number coming out at a lower than expected -4.1%.
On balance, however, especially bearing in mind high wage settlements, these risks to the inflation forecast probably remain skewed to the upside.
This may embolden the SARB to remain on hold with its next interest rate decision in late August, prime probably remaining at 11%.
Source: Cees Bruggemans, FNB, August 3, 2009.
