Nedbank Economic Comment : CPI - June 2009

Consumer inflation fell to 6,9%, below market expectations and to a rate last seen in November 2007. This supports our view that the inflation outlook will have improved sufficiently towards the end of the year to give the Reserve Bank some space to cut rates further.

Food prices fell by 0,4% m-o-m, taking the annual increase to 9,9% from 12,4% in the previous month. Fruit prices fell by 6,5% m-o-m, due to seasonal factors, while declines in bread and cereals, meat, fish and vegetable prices, were also contributors to the monthly decline.

Owner’s equivalent and housing rentals rose strongly over the month, contributing over half the monthly increase in inflation. However, on an annual basis rental inflation continued to moderate, easing to 5,6% from 6,4% in the previous month and 9% a year ago.

Fuel prices rose by 2,2% over the month, but continued to fall over the year, declining by 25%.

Outlook

Our preliminary inflation forecast for July suggests a modest decline to 6,7%. Over the month, prices are expected to rise by 1,1%, mainly due to the 31% increase in the price of electricity, which will add roughly 0,6 percentage points to the monthly increase. Higher petrol prices will also contribute towards the monthly gain.

Inflation is expected to ease further over the coming months due to base effects. A slowdown in the rate of food price increases over the remainder of the year will ensure that food price inflation continues to moderate further (see box below). The rand’s recent strength as well as weak demand conditions will also help to contain price increases. However, second-round effects appear to be well entrenched in the economy, making prices extremely sticky. Added to this, above-inflation wage demands, which have so far been insensitive to the severity of the recession, will add to inflationary pressures.

Implications

The period of aggressive easing is over. However, towards the end of the year the current optimism around the ‘green shoots’ of recovery may have turned more realistic, with the short-term boost provided by fiscal stimulus packages and the turn in the inventory cycle beginning to dissipate. Policymaker’s attention will turn to the prognosis for economic growth for 2010, which is likely to remain weak and well below potential. The rate of easing in inflation will probably pick up some pace by then. This should tip the scales in favour of further modest rate cuts before the end of the year, bringing prime down to 10% at the bottom of the cycle.