The National Treasury and the Reserve Bank have divergent views on inflation, but this will make little difference as to when we can expect to see a rate cut – namely April next year. The latest economic indicators show the economy is under continuous pressure, but inflation fears will be the driving force behind interest rate policy.
In the medium-term budget treasury estimated that inflation for next year would average 6,5% and that it would come into the 3% to 6% target range before the end of 2009. The Reserve Bank, however, believes inflation will average 6,9% next year and come into the target range only within the next 18 months.
During the medium-term budget address to media last month Finance Minister Trevor Manuel said he expected that the Reserve Bank would review its inflation numbers, which would come in line with treasury’s view, and that this would be reflected in this week’s monetary policy review.
Although the Reserve Bank has stuck to its previous forecast on when inflation will come back into the target range, its new chart shows a significantly faster drop in inflation in the first quarter of 2009 than it had forecast before. Within the second half of next year the bank expects inflation to hover just above the critical 6% level.
The sharp fall in inflation is partly a result of lower-than-expected oil prices and a significantly weaker global economy, but it primarily results from the reweighting of the inflation index, which is expected to shed 2% off the inflation figure when January’s data is released in February.
The bank is allowing for a significant forecasting error, as the volatile rand makes forecasts on imported inflation virtually impossible. If the rand recovers substantially we could see inflation come into the target range early next year, but a further fall from these levels could see inflation remain well above target for the remainder of 2010.
For this reason it is unlikely that an early rate cut would be considered by the monetary policy committee (MPC), which remains wary of the currency risk. This is despite further evidence of an economy under pressure, with car sales, manufacturing and property all continuing to decline. Passenger vehicle sales recorded a 33,4% decline year on year and commercial vehicles fell by 24,4%, according to the National Association of Automobile Manufacturers of South Africa.
“The weakening trend is obviously a significant concern given the size of the industry in terms of manufacturing and distribution and the likely impact on employment, especially the closing down of car dealerships,” said Stanlib economist Kevin Lings.
Pressure on the manufacturing sector continues with the Investec Purchasing Managers’ Index (PMI) falling to 46,2 index points in October from 47,7 in September. A level below 50 indicates contraction in the manufacturing sector. Manufacturing is feeling the effects of the slowing domestic and global economy while facing higher input costs because of currency weakness. Although Statistics SA reported positive manufacturing growth from May to August, Nedbank Capital Research said the PMI is usually a good leading indicator and that when figures are released in September it is expected to show a contraction in the manufacturing sector. Property prices remain under pressure, with Standard Bank’s property gauge showing a 2,5% decline in property prices compared with last year.
Despite the economic slowdown, Nedbank Capital economist Ian Cruickshanks said that as the new inflation figures, based on the reweighted basket, will be released only after the MPC meeting in February, it is unlikely that the Reserve Bank will cut rates before its April meeting because it would want to understand fully the impact of the new basket on the inflation figures.