First the good news: the oil price spike witnessed recentlyis a temporary phenomenon, set to last only a few months. The bad news is that, because the greenback has strengthened over the past month, there is no inflationary shield usually offered by a weaker dollar. This is the view of Dennis Dykes, chief economist at Nedbank.
Dykes says this week’s spike in Brent Crude oil prices to near $60 a barrel is largely caused by the northern hemisphere summer, when demand usually rises. He expects the price to ease off in the next three months, before rising again at the end of the year — the deep winter months of the northern hemisphere.
Dykes does not subscribe to the view held by Goldman Sachs, which recently warned that oil prices could touch $100 a barrel.
Because of recent dollar strength, the shield normally offered by a weaker dollar — which strengthens the rand — no longer applies, says Dykes.
But dollar strength is not expected to last long. Last week’s news that the United States’s current account deficit reached a record level of $195,1-billion, or 6,4% of gross domestic product, in the first quarter of this year is seen as source of future weakness.
Dykes expects faltering US growth and the Federal Reserve’s limited ability to raise rates to conspire to undermine the greenback.
On the local economy, the oil price spike will have minor effects. Dykes says the petrol price could reach R5,23 a litre next month. This will edge inflation slightly upwards.
He expects CPIX (inflation minus mortgage rates) to come out at 4,1% for May when released next week. It should stay at that level for June before spiking to 4,5% for July. That will be partly owing to the petrol price, but also because inflation is coming off a lower base and food prices will rise slightly on the back of a weaker rand.
Dykes is reluctant to enter the choppy waters of forecasting the rand, but says he expects it to end the year at R6,70 — “with many health warnings” — before weakening early in 2006. On Wednesday, the rand closed at R6,73 to the dollar.
Current market conditions leave room for a 0,5% cut in interest rates before the year end, that is provided the rand remains above R6 to the dollar.
Concurring with this view is Merrill Lynch economist Nazmeera Moola, who recently noted that “any attempt to guess what rand level will trigger a rate cut will be vague at best”. But she says that R6,50 will not be enough to induce a cut, hence the critical R6 level.
Moreover, Moola does not see a 50 basis point cut as being a spur for any rand weakness, suggesting instead that rand weakness can only be sparked by a downturn in the commodity cycle.
She expects the rand to weaken only in 2006, by moving from R6,20 at the end of this year to R7,50 at the end of 2006. This would imply a 20% rand depreciation on a trade-weighted basis, bringing some respite to the export sector.