The Reserve Bank should maintain a tight policy stance for a while, including possibly imposing a further rate increase this month, to prevent inflation and inflationary expectations getting out of hand, said Rian le Roux of Old Mutual Asset Managers (Omam).
In his latest economic forecast Le Roux said South Africa’s CPIX inflation rate could rise to around 10%over the next few months as the prices of imported goods have yet to reflect the full effect of the rand’s fall.
”Such an increase in inflation is unavoidable and cannot be prevented through monetary adjustments. However, it is crucial that the Reserve Bank prevents this round of price increases from becoming a more permanent phenomenon of higher inflation.
”This could happen if the present series of price shocks were to generate a wave of bigger wage increases and if the Reserve Bank allowed money supply to continue growing rapidly.”
Le Roux said unfettered second-round inflationary pressures would negate the progress made since the mid-1990s in reducing inflation and inflation expectations.
”If inflation again settles at higher levels, real interest rates may have to be hiked substantially some time in future in order to bring it back under control.”
Higher local cost structures would dilute the benefits of the weaker rand to exporters and the broader economy. If inflation became entrenched the credibility of South Africa’s economic policy makers would be damaged.
”We are therefore in favour of the Reserve Bank taking further action to prevent inflation and inflationary expectations from once more getting out of hand. Measures to bring inflation under control now will be far less painful than having to deal with permanently higher inflation at a later stage.
”The painful truth is that South African consumers will have to put up with higher interest rates including a further hike later this month for a little while longer.”
But if the Reserve Bank applied a sufficiently firm policy hold for the remainder of the year and the rand maintained current levels, inflation should decline next year and be inside the six to three percent target range towards the end of 2003.
Le Roux said the biggest risk to this scenario was if wage increases soar over the remainder of this year. If this happened, interest rates could rise still further after the next hike.
”As far as the interest rate cycle is concerned, we believe that the expected hike this month will be the last. Interest rates could start to decline again during the first half of next year if the rand remains at current levels and inflation peaks later this year.”
This year the economy should match 2001’s growth of a little over two percent which was disappointing compared with other emerging markets and continued high unemployment.
But prospects were brighter for 2003, with projected growth of over three percent due to reasonably robust world growth and a competitive currency. A continued stimulatory fiscal policy and a renewed easing of interest rates would boost domestic demand.
Commodity prices, the trade balance and international investor sentiment towards emerging markets should continue to help the rand which is still very cheap in real terms. The Reserve Bank’s net oversold position in the forward market was likely to be wiped out by the end of the year.
”For these reasons we expect the rand to move sideways for some time still and would not be surprised if it continued to strengthen moderately. This does not negate our view that the rand remains very vulnerable. Any bad news from the South African region or a renewed downturn in global growth and commodity prices could once more put downward pressure on the currency.” – Sapa