Scene set for rates to be slashed

Johannesburg - Inflation came in better than expected in December, falling to 10.3% from 12.1% in November last year and raising hopes among some economists that the Reserve Bank will cut interest rates by as much as 100 basis points when it meets next week.

Inflation broke through the Reserve Bank's 3%-6% target range for CPIX inflation - the consumer inflation rate excluding mortgage interest rates - in April 2007.

Driven by high food, fuel and electricity prices, inflation hit a peak of 13.6% in August. A sharp fall in the fuel price was one of the reasons for the decline in inflation in December.

Standard Chartered economist Razia Khan welcomed the better-than-expected fall in inflation. "With inflation improving this rapidly, and with the data on the real economy increasingly downbeat, and job losses in mining taking centre stage, there are few reasons for the Reserve Bank to maintain interest rates at a high level," she said.

Khan expected interest rate cuts of 100 basis points at the meeting next week and in April, followed by cuts of 50 basis points at each of the next two meetings.

Absa economists said they expected inflation to fall back within the target band by mid-2009, with the Reserve Bank likely to cut the repo rate by 100 basis points at the February 5 meeting followed by a further 100 basis points cut at the April meeting.

But not all economists agree that the Reserve Bank will act aggressively. Standard Bank economist Danelee van Dyk said the Reserve Bank would be cautious, given the "brewing risks in the currency market", and would cut by only 50 basis points at meetings this year.

This would be the case despite Van Dyk expecting the inflation rate to drop by three percentage points in January, when Statistics SA brings in a new basis of calculation.

ETM economist Russell Lamberti agreed with Van Dyk that the Reserve Bank would cut by only 50 basis points. "We would like to see the Bank err on the side of caution," he said.

On downward trajectory

The Reserve Bank raised the repo rate by five percentage points between June 2006 and June 2008, bringing the prime overdraft rate to 15.5%. The Bank then cut the repo rate by 50 basis points in December - a move regarded as too timid by some economists.

The small rate cut took place against the backdrop of the release of particularly weak gross domestic product (GDP) figures for the third quarter, which showed GDP grew by a marginal 0.2%. The rate of growth was the lowest in 10 years.

In its last monetary policy committee (MPC) statement in December, the Reserve Bank said inflation was expected to continue its downward trajectory, and to return to within the 3%-6% target range in the third quarter of 2009. Previously, the Bank had expected a return to the target range in the second quarter of 2010.

The MPC statement also said inflation would again breach the upper limit of the target range in the first quarter of 2010 as a result of technical base effects associated with the decline in petrol prices at the end of 2008. However, after that, the downward trend in inflation was expected to resume.

The MPC said inflation was expected to average 6.2% and 5.6% in in 2009 and 2010 respectively, and to average 5.3% in the final quarter of 2010. "The forecasts are subject to a greater degree of uncertainty than usual, given the highly volatile global environment, and the uncertainty related to the impact of the rebasing and reweighting of the CPI basket to be introduced by Statistics SA in January 2009," the bank said.

Stats SA is expected to release the CPI indices for last year on the new basis of calculation on February 3. The idea behind the Stats SA release next week is to help the Reserve Bank in its monetary policy decision, and to enable economists to forecast inflation for January.

CPI will replace CPIX as the targeted measure of inflation, as the component mortgage costs in the CPI will be replaced by "owner's equivalent rent". Up to this year, homeowners' cost of living in their houses had been measured by mortgage interest rates in the CPI, leading to the perverse outcome that an increase in interest rates leads to an increase in inflation. That's why CPIX was targeted.

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- Fin24.com