Steep rate cut expected in Feb in South Africa

Jan 07 2009 17:48 Ines Schumacher

Johannesburg - Inflation could fall to as low as 6% in January and therefore back into government's inflation band - a development that could prompt a heavy cut in interest rates, economists have said.

"The inflation rate for January stands to decline massively from the 12.1% CPIX inflation rate for November to little over 6% for January," said Tony Twine, a senior economist for Econometrix, in a note to clients. CPIX, or the consumer price index excluding mortgage bonds, represents the cost of certain goods for the man in the street.

"Our prediction is 7% which is a dramatic fall in the inflation rate," said Kay Walsh, an economist at Rand Merchant Bank (RMB).

The South African Reserve Bank would then weigh into interest rates, she said. "We forecast that the MPC [monetary policy committee] will cut 50 basis points at every meeting until the end of the year."

Twine predicts that interest rates could be cut as much as 100 basis points at the MPC's next meeting, scheduled for February 11 and 12.

A 60% decline in the price of oil from its 2008 peak of about $147/barrel and technical changes to the way inflation is calculated in South Africa were behind the lower inflation expectations. Oil is trading at about $48/bbl.

Apart from the petrol price cut, lower food costs and the replacement of interest on home loans with owners' equivalent rent (the rental a homeowner forgoes by living in his house instead of renting it out) would present a convincing argument to the MPC to cut interest rates, said Econometrix in its Ecobulletin dated January 5.

As for the re-weighting of the CPI, it is a recurring statistical procedure. "The new weights would most likely result in a decline in the level of measured inflation," said Statistics SA on its website. For one, food will carry a smaller weight, while vehicles will carry a higher one.

Even though the January inflation rate will be unavailable to the MPC at its February meeting, it can make an accurate estimate to base its decision on, said Twine.

"If the MPC decides to cut interest rates in February and April, it would remove cost pressure from households and business, because of the reduction of inflation against the background of rapidly rising wage rates," said Twine.

However, RMB's Walsh said that there was a risk to the rand if interest rates were cut too drastically. RMB's prediction is more conservative; there has been a tendency in the past for the MPC to cut interests more when inflation falls rapidly, said Walsh.