Inflation Worries

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South Africa's manufacturers received some unwelcome news at the end of July with the prospect of another interest rate increase looming on the horizon. Inflation appears to be on the rise again in South Africa, prompting speculation that South Africa Reserve Bank (SARB) Governor Tito Mboweni could initiate a second consecutive rate hike.



The increase in the South African consumer price index less mortgage costs (CPIX) targeted for monetary policy rose by 4.8% in the year to June after an annual increase of 4.1% in May, which was the largest rise since August 2005, according to data from Statistics SA. The consumer price index (CPI) increased by an annualised rate of 4.9% during the month - against 3.9% in May - its highest level since August 2003.



Another matter of concern, and one raised by Mboweni at the June meeting of the bank's monetary policy committee, was the country's current account deficit, currently standing at 6.4% of GDP, a 24-year high.



A rate hike will not be welcome news to South Africa's manufacturers who, after a brief respite in recent months, are once again facing the prospect of a strong rand, with the local currency having appreciated by 7.5% in the last four weeks. However, manufacturers are hoping that the strengthening rand will convince the SARB governor that a further rise will be unnecessary.



Brokerage firm Lehman Brothers recently predicted that high commodity prices could push the manufacturing sector into recession, and the governor will want to avoid such a scenario if it can be helped. The SARB increased the repo rate by half a percent to 7.5% in June 2006 and analysts are predicting a similar rise before the year is out, with some suggesting an increase as soon as August. However, given that rates have just risen slightly from a 25-year low, most analysts believe that a cumulative rise of 1% will have little effect on South Africa's consumers.



Recent figures released by the government showed that the increases in inflation were largely driven by rising food prices, which rose by a year-on-year rate of 7.7% in June compared with 6.9% in May. Food prices are, of course, closely linked to fuel costs and with the current situation in the Middle East being what it is local analysts expect this trend to continue.



South Africa's transport costs are currently rising at an annual rate of 9.6%, a jump from 6% just three months ago as domestic fuel prices increased by nearly 6%. The CPIX takes its measurement from the price performance of five key commodities, but oil has the greatest weighting attributed to it because of the far reaching cost implications it has for many sectors of the economy.



Surging fuel prices were one of the issues addressed by Mboweni in comments published on July 31, based on a speech he gave to the Rand Club three days earlier.



"As is the case internationally, the high oil price, if sustained, poses a significant threat to inflation and economic growth in South Africa," he said, adding that domestic consumption spending, balance of payments problems and higher than expected producer prices also posed major inflationary threats.



Despite this, some analysts believe that the government's figures are overly pessimistic. The rand fell from just under R6 against the greenback in March to a two and half year low of R7.52 last month, so a rise in the CPIX had been expected. The slide came on the back of the widening current account deficit and a loss of confidence in emerging markets.



Perhaps the most interesting aspect of the recent crisis in the Middle East from a South African perspective has been how well both the Johannesburg Stock Exchange and the rand have performed. While investors have been looking to move balance portfolios that are overextended in emerging markets into safer investments, the rand has re-bounded and commodities stocks have been performing nicely. This is known as the "Goldilocks scenario"; with investors looking for safe havens such as gold, South Africa benefits by keeping investment levels on an even keel whether in good times or bad.



While manufacturers will not like the prospect of the rand remaining below seven to the US dollar, it is infinitely better for the overall economy to have a currency that remains stable than a return to the roller coaster ride of the first years of the new century.

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