There is little doubt that there will be a further rate hike when the monetary policy committee meets next week. Inflation numbers have crept up to 5%, a rapid rise since its near-term low in April of 3,7%.
Producer price inflation (PPI), which ultimately feeds into consumer inflation, continues to be a major concern, especially as imported capital and raw goods have started to climb as a result of rand weakness.
The announcement by Mittal Steel South Africa earlier this week that it would increase prices on steel by 7,5% indicates that the pressure on PPI is not yet over.
It now seems certain that inflation will start testing 6%, the top end of the inflation target, by next year. Already, according to economist Kevin Lings, the high levels of inflation on food and transport mean that inflation for the low- income earner has already hit 6%. Despite this, Reserve Bank Governor Tito Mboweni is expected to only increase rates by 50 basis points.
Although consumers appear not to have taken heed of the governor’s warning — with credit extension numbers breaking new records each month and reaching 25% in August — at a recent address to the South African Institute of Charted Accountants, Mboweni indicated a concern about allowing too great a shock to the system.
He indicated that he would prefer a softer landing and was particularly concerned about the impact of volatile interest rates on home- owners, especially those in the emerging black middle class.
Although it may be too soon to read much into consumer credit — there is generally a lag effect on interest rates — the latest slowdown in house prices does indicate that people are becoming increasingly concerned about the impact of mortgages.
According to Standard Bank’s latest residential property gauge, growth in house prices is slowing drastically with prices in September only 2,9% higher than last year.
While inflation and the burgeoning current-account deficit may be a reason for concern, there is a beacon of hope and that is that the economy is growing. Inflation and current account deficits are generally a symptom of a very stimulated economy.
GDP figures show that growth is robust with second-quarter figures for this year coming in at 4,9%, well above expectations. Agriculture was the only drag on the numbers and excluding agriculture the economy would have grown at 5,8%, which is very close to the government’s targeted 6% growth by 2014.
The Investec’s Producer Manufacturers Index (PMI) is currently sitting at 59,8, marginally down from July, which was the highest level on record.
According to Lings, the PMI index has been above 57 for four consecutive months, confirming the recent recovery in the manufacturing sector. “The current improvement is extremely encouraging in that it suggests that not only had the manufacturing sector learned to cope with the stronger rand that prevailed during the early part of 2006, but it is now also benefiting from some currency weakness.”
The manufacturing sector comprises about 17% of South Africa’s total GDP.
Lings points out that a higher interest rate will impact on manufacturing, both by dampening consumer enthusasim and increasing cost of capital. However, this impact could be offset by rand weakness and curtail import demand, encouraging people to look local.
He also believes that the anticipated pick-up in fixed investment (infrastructural) activity should provide a welcome boost.
One can even take some encouragement that the trade deficit figures, although double the recommended percentage to GDP, did improve marginally in August, coming in at R5,3-billion.
Although this was higher than expected, the rand weakness appears to be having an impact, with exports rising by 3,1% month to month, while imports fell by 3,2% month to month, helped substantially by a decline in oil and fuel imports. The trade deficit, which is currently 6% of GDP, will be the biggest influence on the rand volatility. But Lings warns that “given that consumer spending remains relatively robust and that fixed investment spending is expected to pick-up steadily, the trade balance is likely to remain under pressure”.
However, rand weakness tends to be the cure for overly large trade deficits. Although consumers can still shrug off a 100-basis points rate hike, they may find it a little more difficult to shrug off the 19% increase in the cost of imported goods since the beginning of this year.
As consumers buy less imported goods and exports become more attractively priced, so the current account deficit should start to whittle down and the pressure on the rand will ease.
It is all part of the cycle of an economy and as long as the government does not do anything too rash and Mboweni sticks with his soft-landing policy, the strong fundamentals underpinning the economy should see us ride the storm fairly unscathed.