Inflation set to dive in 2009
Sep 10 2008 07:55
Roelof Botha
Johannesburg - The inflation debate has taken a very welcome turn in recent weeks. Since the end of 2006 almost all influential opinion leaders across the economy, as well as factual reports on inflation trends, have painted a gloomy picture.
The relentlessly rising oil price, imbalances between food production and the demand for grains, in particular, as well as hikes in the prices of other raw materials, have been pointed out with monotonous regularity.
Food and raw materials
No country in the world has been spared this rising inflationary trend.
Even England - the world's fifth-largest economy and a country that for about a quarter of a century experienced pricing stability - has not been able to sidestep the deadly combination of higher energy costs, higher food prices and the escalating raw materials cycles.
In July these factors also caused British producer prices, on a year-on-year basis, to notch up double-digit growth for the first time in more than two decades.
Other countries in Europe have also experienced sharp increases in producer prices, but amid the systematic and relentless push of service sectors as the principal drivers of economic expansion and growth, consumer prices in Western Europe have risen only marginally.
In most developing countries the primary sectors and manufacturing still play a far greater role in overall economic activity, and it's not surprising that since last year inflation has risen steeply in almost all emerging countries. In some cases it has even doubled. In South Africa's case, the weakening of the rand between the end of last year and the middle of this year has naturally contributed to inflation rising more than in countries with a more stable and stronger currency.
The turnaround
Economists will, however, be delighted with the news that producer prices in England came down in August.
Although the year-on-year figure is still above 9%, the country's core producer price index also fell in August - for the first time since 2005.
Several economic analysts have been caught on the wrong foot by these favourable developments.
There had been an expectation that high inflation would continue, owing to the so-called "drag" effect.
If producer prices continue to fall, consumer prices will probably also soon begin to fall on a month-to-month basis, which one hopes will lead to a turnaround in negative attitudes towards inflation expectations.
Unfortunately there is still a dark cloud hanging over the picture - namely wage demands from the unions.
One of Germany's largest trade unions (IG Metal) is currently insisting on a 7 to 8% wage increase.
Unless these demands are adjusted to a more realistic expectation for inflation, or they keep pace with increases in productivity, it will take longer before inflation falls back to the levels seen early last year.
The essential reason for the sudden and sharp turnaround in inflationary trends can be ascribed mainly to real declines in the prices of resources.
After years of continual rises in the prices of energy sources, food, fertilisers, precious metals, steel and other raw materials, almost all resources have fallen back between May and August, as the accompanying table clearly indicates.
Fertiliser and timber products are among the few exceptions.
In most cases resources fell even further during the first week of September.
On Monday, the oil price dropped below the $100/barrel level, 32% lower than its record price two months ago.
Even were resources prices to stabilise at current levels in the coming months, it is clear that the back of inflation has more or less been broken.
Although the higher interest rates we saw earlier this year will persist for several more months on an annualised basis, month on month increases should begin to trend towards zero, even becoming negative.
Low interest rates
In the case of South Africa, the prospects for significant declines in interest rates or becoming rosier. In addition to the universally positive effects of lower oil and food prices, the rand has strengthened in recent months and in January a bonus is on the cards for consumers (and homeowners) when the new system for measuring consumer expenditure comes into operation.
It's strange that Statistics South Africa should decide to wait until next year before using the new basket of goods and services representing household expenditure to calculate the consumer price index (CPI). (The country's authorities are in the habit of putting off decision-making - such as in the case of new power stations, the upgrading of Durban's port, and the operations of the Land Bank.)
It has become clear that inflation will drop in January, probably by more than two whole percentage points, following a technical alteration to the CPI.
If the current composition of the CPI basket is examined more closely, it's clear that South Africa's inflation rate could drop like a rock early next year.
The groups for food, housing and the running costs of vehicles (mainly fuel) make up considerably more than half the average South African's total expenses.
Declines in the cost of food and fuel are already evident, while lower interest rates will naturally lead to a reduction in the cost of housing.
Interest rates should therefore be systematically reduced next year, and a return to a 5% economic growth rate is just around the corner.
- Fin24.com
Dr Botha is economic adviser at PricewaterhouseCoopers.
