The Reserve Bank increased the repo rate (the rate at which banks can borrow money from the Reserve Bank) in August by half a percentage point. Commercial banks followed, increasing their prime lending rate to 13,5%, the highest level since September 2003.
Factors influencing inflation
The Reserve Bank uses the rate of inflation excluding interest on home loans (CPIX) as their main policy indicator with a target range of between 3% and 6%. CPIX inflation breached the upper 6% limit in April 2007 (6,3%) and June 2007 (6,4%). Producer price inflation, which usually translates into consumer inflation with a few months’ lag, showed that higher prices were decreasing. Higher oil prices, wage settlements of more than 8%, too-high consumer demand fuelled by consumer credit and a weaker rand all contributed to the Reserve Bank’s decision.
The Reserve Bank has shown in the past that they are quite willing to reduce interest rates if there are indications that inflation will move to the lower band of the 3% to 6% range. Inflation expectations remain the main factor driving the Monetary Policy Committee’s decisions, although they do take other variables into account.
Oil price impact
The oil price remains a critical factor, directly and indirectly. Higher fuel prices result in higher transport costs for consumers and higher consumer prices generally. The Reserve Bank is thus very sensitive to a
rise in the oil price.
In January 2007 the price of Brent crude oil was at a 20-month low of US, but has since reached US and even US at one stage. Oil prices will probably remain volatile with OPEC using their clout to prevent prices from dropping. The danger of higher inflation as a result of oil prices remains a real one.
Food prices are the other major inflation risk. Recently the National Agricultural Marketing Council (NAMC) published food price trends for the year ending 31 July 2007. While Stats SA calculates food inflation between June 2006 and June 2007 at 9,5%, the NAMC report shows that food prices increased by 13,8% between July 2006 and July 2007. The price of most food items, with the exception of eggs, fruit and vegetables, increased by more than 6%.
Multi-level price increases
At the farm level, food prices increased by 15,6% year-on-year to June 2007, at the processing level by 15,3% and at the retail level by 9,5%. This shows that the increase in farm producer prices over the last couple of months will result in higher retail food prices, even though many retail prices have already increased – in some cases in anticipation of higher farm prices.
International grain prices are largely driven by US demand for their developing biofuel industry. Since the beginning of 2006 yellow maize prices have moved close to US0 and higher, after previously remaining stable at or below US0 for 18 months. Soya prices also increased as a result of higher biofuel and feed demand. The price of other grains such as wheat and rice also increased because of higher demand. International dairy prices are at their highest for many years and experts predict a continuation of current prices
for at least the next decade. Food inflation will thus remain a source of concern to
the monetary authorities.
The current increase in interest rates may have the desired effect on demand. If so, this may be the last interest rate hike in the current cycle. The Reserve Bank may also hesitate to increase interest rates further because of undesirable side-effects. For example, a higher South African interest rate combined with a lower US rate may result in a stronger rand, which we can ill afford with our current account deficit (the country’s overdraft) at 7% of our GDP.
All these factors indicate that inflation may stay at or near the top of the target range for the next few months. While the current interest rate increases are probably, given current conditions, the last of the cycle, major uncertainties such as the global oil price and the exchange rate may impact negatively on inflation. If inflation stays above 6%, the Reserve Bank will not hesitate to increase interest rates by another half to one percentage point.
Current higher producer prices and favourable expectations for the next year or so may encourage farmers to expand their businesses. If so, they must take into account the possibility of higher interest rates and also that food demand may decrease as consumers find it more difficult to make ends meet at higher interest rates. This is especially true for emerging consumers, who are very highly indebted.
Cash-flow analysis must include a risk premium of 1% to 2% as well as conservative future price estimates. – Dr Koos Coetzee is an agricultural economist at the Milk Producers Organisation. All opinions expressed in this column are his own and do not reflect
MPO policy. |fw
