/ 20 April 2011

Reserve Bank has tough call on high CPI

South African inflation was higher than expected in March, while retail sales growth for February slowed, suggesting the central bank will have to time any interest rate tightening carefully so as not to strangle growth.

The South African Reserve Bank ended its monetary loosening cycle in January, leaving the repo rate steady again at 5,5% in March after reducing it by 650 basis points between December 2008 and December 2010.

The consensus among economists is that the next adjustment in rates will be up, but the timing of the move is not yet clear.

In March, the monetary policy committee statement was cautious, highlighting the ongoing recovery in Africa’s biggest economy along with risks to the inflation outlook especially from food, oil and administered prices.

This week, Reserve Bank Deputy Governor Daniel Mminele said the bank will base policy action on an assessment of second-round effects of higher oil and food prices on inflation.

Data on Wednesday showed annual inflation in March quickened to 4,1% while retail sales growth slowed to 5,6% year-on-year.

“From the Reserve Bank perspective it’s not good to see inflation increasing while demand is still struggling. It’s not good for job creation or economic growth,” said Freddie Mitchell, economist at Efficient Group

“We think interest rates will increase by one percentage point by the end of this year, so two 50 basis point hikes.”

Jobs, and more jobs
South Africa’s recovery after a recession in 2009 has been sluggish, with both the manufacturing and consumption sides of the economy recovering at a slow pace.

The central bank said manufacturing output was still underperforming and while consumer expenditure growth would remain robust it was unlikely to accelerate excessively.

At 2.8%, last year’s GDP growth pales in comparison to the average 5% between 2003 and 2007. Even this year’s GDP forecast of 3,4% is just not enough to make a dent on unemployment — the main bugbear of the government.

The economy will have to grow by 7% a year for 20 years to bring joblessness down from current levels of about a quarter of the labour force.

The Reserve Bank will have to tread carefully in its timing of the next tightening cycle so it does not strangle growth.

“The bank will not overreact of course, but this [inflation] print will set the market thinking about how soon we might need to see tightening in South Africa,” said Razia Khan, head of Africa Research at Standard Chartered in London.

Most analysts in the Reuters Econometer expect interest rates to rise by 50 basis points by year-end.

But Absa Capital economist Jeffrey Schultz said the Reserve Bank will wait for a more broad-based recovery in the economy before starting to raise rate early next year.

“We must be careful not to look too much at one month’s print. On a seasonally adjusted quarter-on-quarter growth is quite strong,” he said referring to retail sales data.

“Core inflation is actually benign at 3% in March and hasn’t done much in the past couple of months highlighting weak demand. So we don’t believe the tightening cycle is likely to start anytime soon.” — Reuters