SA’s sticky inflation should start behaving into 2010

Vivienne Taberer, portfolio manager at Investec Asset Management, mulls the reasons for South Africa’s sticky inflation, but looks forward to a far better behaved CPI into 2010.

After seven months of nasty surprises on the upside, some commentators are tentatively suggesting that CPI inflation, due tomorrow, may just pleasantly surprise the market by coming in lower than expected. We are not quite as optimistic, but our forecast of around 7.2% (almost in line with consensus) is a welcome drop from the 8% recorded in May.

So why has inflation in South Africa been so sticky, especially compared to our emerging market counterparts? In addition to high administered prices, wage negotiations and inflation expectations have been a matter of concern, as they tend to be backward-looking rather than forward-looking. High commodity price inflation and the massive sell-off in the currency towards the end of last year were not just particular to South Africa, but to most emerging markets. Elsewhere, however, particularly in Brazil, Mexico and Chile, the inflation unwind was much quicker and unit labour costs and inflation expectations were far better anchored to the target range. In South Africa, the job for policy makers has been made very difficult by the fact that we have not been able to contain unit labour costs and longer-term inflation expectations, with the result that we are seeing some second-round effects.

Secondly, the currency sell-off has been problematic in that the pass-through appears to have been asymmetric. While on the import side there appears to have been a knee-jerk reaction in trying to pass through the rand weakness, the subsequent rand strength has taken far longer to filter into the inflation numbers.

Finally, we are concerned that the composition of the inflation basket and the way in which some of the categories are calculated, are inclined to overstate inflation. The manner in which the inflation number for categories such as clothing, tradables and cars is calculated excludes sales or discounts. In a normal business cycle this wouldn’t be an area of concern, but given that there are more price reductions during periods of economic stress, the inflation number is likely to be distorted if all these discounts are not captured.

So although inflation is likely to remain sticky into year-end, there is some good news on the horizon. By next year, we expect price increases to be more contained and CPI to remain well within the target band. It may even surprise consistently on the downside. Indeed, in our view, we don’t anticipate that there will be any reason for the SARB to raise rates during 2010, although the market is pricing in a rate hike by the third quarter.

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SA’s sticky inflation should start behaving into 2010

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