On CPI inflation and the Rand

A couple of data releases out recently confirming our expectation of a stronger Rand (average of USDZAR of 6.40 in 2010), lower than expected CPI inflation (testing of 3% y/y in H2 2010), and high likelihood of a  lower repo rate price-fixing by the SARB later in the year (up to cumulative 200bps lower over 2010-11).

From Fin24:

Johannesburg – South Africa’s consumer inflation as expected slowed back into the central bank’s 3% to 6% target range in February, keeping alive hopes of an interest rate cut this year.

The easing to 5.7% year-on-year (y/y), a more than three-year low, from January’s 6.2%, suggests price pressures are cooling although month-on-month (m/m) inflation quickened.

The retreat into the band comes a month ahead of the Reserve Bank’s forecast and further easing could add to chances of a rate cut.

We don’t expect that Eskom electricity tariff hikes will place upward pressure on CPI inflation, and maintain our view that Eskom hikes will be deflationary over the coming year. Low to no credit- (PSCE -1.2% y/y in Jan 2010) and money supply growth (M3 +1.6% y/y in Q4 2009) is to continue over the short-term and we expect these forces will conspire to keep downward pressure on CPI inflation. To put a number on it, we expect CPI inflation will test the lower end of the target band of (3%) in the second half of 2010. Furthermore, the abovementioned factors will also see to a stable and strong Rand exchange rate over the period.

Moving on to the effects of a strong Rand on the economy – recall Cosatu and other interest groups’ recent claims that the Rand will stunt export growth? Data from the SARB’s quarterly bulletin show that the strong Rand hasn’t killed the export sector as many expected. From Fin24:

Johannesburg – The strong rand has not impaired South Africa’s export potential – as many exporters and unions had said it would.

The fourth quarter’s 2.8% gross domestic product (GDP) deficit on the current account – surprisingly smaller than expected – showed that pleas for a weaker currency do not make sense.

In fact, amid all the claims that a strong rand hurts exports, the statistics show good growth in both export volumes (6.6% higher) and value (up 10.7%). Other analysts agree that these data indicate the rand is not a culprit.

We didn’t expect the strong Rand would stunt export performance, job creation and GDP growth, but hey, don’t say we didn’t put this view out there.

We expect these factors will hold important implications for monetary policy going forward. The nature of the credit- and money printing induced business cycle will be volatile over the coming few years (to say the least). The moment a big economy like the US or China stutters (which we expect for various reasons), SA will suffer the consequences, particularly in the industrial sectors, just as it did in late-2008 early-2009. At this point — and once job losses again begin to mount – we expect the SARB and Treasury will get in the Rand’s appreciating way and intervene to weaken against the world’s major currencies in an attempt to support the SA economy. We also expect the repo rate to be lowered by as much as 200 bps before the end of the easing cycle. Of course by weakening the Rand, all the government will be doing is redistributing wealth from the poor to the wealthy and better-informed. But this won’t stop them.

Until then, we expect the Rand will continue to appreciate against the major currencies such as the euro, pound sterling and the US dollar.

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