RMB RESEARCH ECONOMICS 01 October 2009 FALLING CONSUMER INFLATION HIDES A WORRYING TREND A closer look at the most recent CPI data reveals that all is not as it seems. Indeed, beneath positive headline inflation trends lie two diverging developments, the one good, the other bad. At first glance, the statistics make for pleasant reading. CPI inflation moderated to 6.4% year-on-year in August from 6.7% in July, and a peak of 13.6% twelve months ago. When breaking down the headline number, similar encouraging trends emerge. Consumer inflation across all expenditure groups is easing, down to 7.1% in the case of pensioners for instance, which is still high but moving in the right direction. Even in rural areas, where inflation tends to be stickier, price increases are slowing nicely. GOODS TO THE RESCUE The reason why CPI inflation has more than halved over the past year, irrespective of expenditure group and geographical area, is a slump in goods inflation (Figure 1). Benefiting from favourable weather conditions, lower input costs and a strengthening rand, food inflation has fallen sharply from high double digit growth in 2008 to 6.1% in August. At the same time, in strongly competitive markets, worsening sales have resulted in lower price increases, or even cuts, as retailers slashed unwanted inventory of semidurable and durable consumer goods. For instance, inflation for household contents and related products has eased from 8.5% a year ago to 6% in August, while prices of household furnishings, textiles and items such as second-hand cars, have been falling for a while now. DIVERGING DEVELOPMENTS But even though goods inflation has decelerated strongly, CPI inflation has fallen less rapidly. The hindrance: high and accelerating services inflation. In contrast to the goods people buy on a regular basis, such as food, petrol and clothes, services are mostly intangible and are obtained less frequently (insurance policies, school fees, TV licenses etc). As services are not as much in the public eye, consumers often forget about services inflation as something that Figure 1: The good news: falling CPI goods inflation y/y% 25 Goods Food 20 15 10 5 0 1998 2000 2002 2004 2006 2008 Source: Bloomberg, Stats SA, Ettienne Le Roux RMB Chief Economist ettienne.leroux@rmb.co.za +27 11 282 8726
continuously chips away at their income. Services account for 46% of the CPI basket, so are almost as important a driver of consumer inflation as goods, which make up the remaining 54%. A WORRYING OBSTACLE So, while the public is benefiting from falling goods inflation (hooray), the reverse is true for services (sulk). After averaging around 7.5% over the period 2007 and 2008, services inflation is now back above 8% with little to suggest the rising trend is about to end, bearing in mind rising electricity costs, water tariffs and assessment rates, for instance. Besides the headline number which is unacceptably high, a detailed look at the services basket itself reveals some alarming developments. In December 2006, around 70% of the broad service categories had year-on-year inflation rates below 6%. Two years later, this ratio dwindled to around 45%. In August 2009, only 30% of services had inflation rates less than 6% (Figure 2). Most disconcerting is the fact that more than half of the 70% of services with inflation rates above the upper limit of the CPI target band are currently running double digit growth rates. Against this backdrop, it is not surprising that most core measures of consumer inflation (CPI excluding food and other volatile goods) remain stuck at around 8%, and this is occurring almost two years into a severe economic downswing. dynamics are playing out in the case of numerous durable and semi-durable consumer goods, although to varying degrees. Even in selected services, theory is working as it is supposed to. Rentals for instance, which account for a third of the CPI services basket, have already seen a sharp downturn in inflation as the recession and associated property market slump has resulted in rising vacancies. But market forces can only work properly in a strongly contested environment, which is largely absent in the case of many services. BROADER FOCUS The Competition Commission is hard at work investigating alleged cartels and monopolistic price fixing. But perhaps part of the Commission s job should also be to find ways of ensuring greater competition in the services industry. As the single supplier of many services, this means that government itself would have to be scrutinised. High and rising services inflation is keeping CPI inflation and, by implication, interest rates higher than ought to be the case. What a pity. For a summary of our key macro-economic forecasts please see page 3. LACKING COMPETITION Theory tells us that a contraction in domestic expenditure, such as we are experiencing today, shifts the demand curve to the left. With the supply curve static, a move of this nature would lead to lower inflation as inventories rise. Indeed, such Figure 2: The bad news: a deteriorating underlying trend % 80 70 Proportion of CPI services with inflation below 6% 60 50 40 30 20 10 0 Dec-06 1 Dec-07 2 Dec-08 3 Aug-09 4 Source: SARB, StatsSA, Page 2
MACRO FORECAST Forecasts 2007 2008 2009 2010 Real GDP (annual average % change) Household consumption 6.6 2.3-3.2 1.1 Government consumption 4.8 5.0 5.1 5.0 Fixed investment 16.3 10.2 2.3 1.5 Exports 7.5 1.7-14.2 4.6 Imports 10.0 2.2-7.9 5.8 Real GDP 5.1 3.1-1.9 2.3 Balance of payments (annual average % of GDP) Current account -7.3-7.4-5.2-5.5 Inflation CPI (annual average - y/y%) 7.1 11.5 7.3 5.8 CPI (year end - y/y%) 9.0 9.1 6.5 6.1 Exchange rates USD/ZAR (annual average) 7.00 8.13 8.56 9.00 USD/ZAR (year-end) 6.84 9.45 8.50 9.50 EUR/ZAR (annual average) 9.61 11.90 11.71 12.28 EUR/ZAR (year-end) 9.97 13.19 11.73 12.83 GBP/ZAR (annual average) 14.05 15.00 13.36 14.99 GBP/ZAR (year-end) 13.57 13.80 14.03 15.96 JPY/ZAR (annual average) 0.060 0.079 0.091 0.090 JPY/ZAR (year-end) 0.061 0.104 0.089 0.090 Interest rates Repo rate (year-end, %) 11.0 11.5 7.0 7.0 Prime rate (year-end, %) 14.5 15.0 10.5 10.5 3-month JIBAR (year-end, %) 11.23 11.42 6.9 7.2 Fiscal policy (annual average % of GDP*) Budget balance 0.6 0.9-1.0-6.5 Note: * Year ending March Source: SARB, Stats SA, I-Net Bridge, National Treasury, Page 3
RMB FICC RESEARCH AFRICAN RESEARCH Celeste Fauconnier: Politics +27 11 282-1923 SOUTH AFRICAN RESEARCH Commodities Research Josina Oliphant +27 11 282-4823 Credit Research Jana Kershaw +44 20 7939-1756 Elena Ilkova +27 11 282-1022 Currency Research John Cairns Nema Ramkhelawan +27 11 282-8656 Data Analyst Raymond Sithole +27 11 269-9969 Economic Research Carmen Nel +27 21 658-9351 Fixed Income Research Bulent Badsha +27 11 282-4146 FICC CONTACT DETAILS Agricultural Trading and Hedging +27 11 269-9800 Customer Dealing and Sales +27 11 269-9230/9175 Distribution and Institutional Solutions +27 11 269-9295 Energy and Metals Trading +27 11 269-9140 FICC Financial Engineering +27 11 269 9030 FICC Sales +27 11 269-9040/9100 FICC Structuring +27 11 269-9150/9030 Fixed Income Derivatives +27 11 269-9065 Fixed Income Trading +27 11 269-9040 Foreign Exchange Forwards +27 11 269-9130 Foreign Exchange Options Trading +27 11 269-9150 Funding +27 11 269-9080 Inflation +27 11 269-9300 Money Market Trading +27 11 269-9075 Nostro Services +27 11 282-1284 Prime Broking +27 11 269-9315 Structured Credit Trading +27 11 269-9295 Structured Trade and Commodity Finance +27 11 282-8542 FICC REGIONAL OFFICES FICC Cape Town +27 21 658-9333 FICC Durban +27 31 580-6390 FICC Port Elizabeth +27 41 374-1750 FICC UK +44 20 7939-1777 Click here for complete FICC contact details http://ficc.rmb.co.za/contacts.asp To subscribe to research, please email research@rmb.co.za Page 4
This research has been written by the financial markets research team at FirstRand Bank Limited (acting through its Rand Merchant Bank Division) ( the Bank ). Distribution of this research in the UK is made jointly by the Bank s London branch and by FirstRand (UK) Limited. Distribution of this research in EEA territories is made by FirstRand (UK) Limited only. Whilst all care has been taken by the Bank in the preparation of the opinions and forecasts and provision of the information contained in this report, the Bank does not make any representations or give any warranties as to their correctness, accuracy or completeness, nor does the Bank assume liability for any losses arising from errors or omissions in the opinions, forecasts or information irrespective of whether there has been any negligence by the Bank, its affiliates or any officers or employees of the Bank, and whether such losses be direct or consequential. Nothing contained in this document is to be construed as guidance, a proposal or a recommendation or advice to enter into, or to refrain from entering into any transaction, or an offer to buy or sell any financial instrument. This research contains information which is confidential and may be subject to legal privilege. It is for intended recipients only. If you are not the intended recipient you must not copy, distribute, publish, rely on or otherwise use it without our consent. Some of our communications may contain confidential information which could be a criminal offence for you to disclose or use without authority. If you have received this communication in error, please notify us at the address below and destroy the communication immediately. This communication is not intended nor should it be taken to create any legal relations or contractual relationships. The Bank is an Authorised Financial Service Provider under South African law. The London branch of the Bank is authorised and regulated by the Financial Services Authority in the UK FirstRand (UK) Limited is a co-subsidiary of the Bank. Both companies are owned by FirstRand Limited, a company listed on the Johannesburg Stock Exchange in South Africa. FirstRand (UK) Limited is authorised and regulated by the Financial Services Authority in the UK to provide arranging and advisor services. Page 5