Shifting Gears

Private Property South Africa
Gina Schoeman

Winter is here, and with it comes a host of cold, hard facts: the prime interest rate is up to 13%, consumers are getting their knuckles rapped for credit levels and robust spending, and the inflation outlook now extends beyond the 6% target. GDP growth is steady and strong, but is showing to be largely dependent on domestic demand. These inflationary pressures point toward an important factor: the gears are changing.

So let’s look at the numbers…

For those who are not too familiar with economic jargon, keep a close eye on food and oil prices from here on. These are, and have been for a while, two of the biggest culprits for the incessant increase in inflation this year. Should these components increase further, it must be considered a possibility that inflation may soar higher. Food is under pressure from inflated grain prices; both drought and the rush to the bio-fuel industry have cut supply. The price of fuel is based on the volatile geopolitical factors of the world and is essentially out of our control. The spin-off to the consumer is that both food and transport are necessary items and as a result, cutback in spending on these two components is difficult.

Source: Statistics SA, SA Reserve Bank, Macquarie Research June 2007

The question that hovers around the dinner tables now is: …but if fuel and food are mainly external factors beyond our control, what is a consumer to do? The third component contributing to higher inflation is consumer spending. The SA Reserve Bank has recently indicated that the high level of household consumption expenditure “is reflected in the high rates of domestic credit extended to the private sector”.

Private credit sector extension (PSCE) came in at 25.1% year on year in April. Despite the somewhat volatile nature of this indicator so far, the trend here appears to be up. This proves some resilience that the private sector has had to recent interest rate hikes. But the rule of thumb states that PSCE should be closer to the sum of GDP growth and inflation. For us South Africans, this should mean a level of roughly 11% for PSCE. I think we can all see the discrepancy here. The recent implementation of the National Credit Act, together with the recent interest rate hikes, should bring this level down to more comfortable levels. But there is no denying that the SA Reserve Bank will be keeping a close watch on the performance of this indicator.

Comforting to this pick up in overall PSCE is that the components made up from consumer credit (asset-backed borrowing, instalment sales and leasing finance) have begun to slow. We expect these components to further decline once the implementation of the NCA begins to take full effect. As for mortgage advances, although this continues strongly, we expect that with the most recent interest rate hikes, the cracks are going to start to show.

And so finally, we come to the crux of the matter: interest rates. The cold, hard fact is that our Monetary Policy follows an inflation targeting regime of between 3% and 6%. Interest rates are the most direct tool that can be used in order to achieve this objective. The SA Reserve Bank’s Monetary Policy Committee (MPC) increased the repo rate to 9.5% at their June meeting, which brings the prime lending rate to 13%.

Source: Statistics SA, SA Reserve Bank, Macquarie Research June 2007

The MPC statement noted that the risks to inflation are on the upside. The

key variables to watch are food prices, oil and consumer spend. Unless oil

prices fall or consumer spend slows sharply in the coming months, there is a

distinct possibility of another rate hike in August. And so until then, we can

only hope that as the temperature drops, so will the host of components

contributing to the strength in the inflation rate.

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