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Thursday, May 1, 2008
Prime suspect

The 9th rate hike in two years means the prime rate has risen by 43% from 10.5% to 15%. FNB Chief economist Cees Bruggemans says this is likely to damage the growth rate of both our economy and our non-mining company earnings (by a couple of percent for this year and more for next year).

Inflation slipping passed 10% only worsens the scenario. Add these factors and how more gloomy can it get:
• Oil prices have risen aggressively. Yet despite the slowing global economy, oil price developments continue to pose upside risk;
• Food price inflation has shown few signs of moderating. Trends at producer level indicate further pipeline pressures. Global food prices are particularly worrisome, with some producer countries restricting food exports, grain prices reaching new highs and futures prices troublesome;
• If the Eskom tariff requests are granted, the electricity price will double by mid-2009;
• The rand has weakened by 16% on trade-weighted so far in 2008, affected by the Dollar, expectations about a widening current account deficit, and increased global risk aversion. Even so, firm commodity prices continue to provide some support.

Scary those these are, Bruggemans, says the supposed good news from abroad is that expert opinion is starting to see light at the end of the tunnel. The tipping point was supposedly the Bear Stearns rescue. Its manner suggests the Fed won t let any institution go under that could pose a systemic risk. However, turmoil is expected to persist for some time and global exchange and financial markets likely to remain volatile.
Wage and salary increases averaged 7.8% in 1Q2008 according Andrew Levy Associates. And the BER survey of inflation expectations indicates elevated ranges outside the target range for a long while to come.
As CPIX inflation moves higher outside the target range of 3%-6%, the danger is that businesses and the labour force will seek matching compensation, embedding such cost increases longer term, permanently moving the inflation rate higher.
Despite the inflation shock being primarily of an external nature, and therefore not easily contained, and despite spreading weakness in the economy due to tighter policy action, loss of purchasing power, lost output due to electricity interruption, and loss of nerve as confidence declines, the SARB is firmly sticking to the mission given it by government
Comments Mike Brown of Seed Investments, “I know that the Reserve Bank is mandated to keep CPI-X in the 3% to 6% band, but thought I’d just check what the official statement is.” On its website under ‘Our mission & vision’ it has the following to say:
The Reserve Bank is committed to achieving and maintaining price stability in the interest of balanced and sustainable economic growth. In the pursuit of its primary objective, the Bank must perform its functions independently, without fear, favour or prejudice.

“Quite clearly price stability (read low inflation) is the main focus.” he comments. The Bank realises that by keeping prices stable it will, over the long run, promote real economic growth. While this strategy works over the long term (much like investing in equities) there will be periods over the shorter term when other strategies may play out to be more beneficial.
“When inflation rises, raising interest rates is the Reserve Bank’s primary tool to dampen spending. This generally results in prices stabilising and inflation coming under control, but while the price of essential products (food and transport) continue to head north, the effects of raising rates on inflation is muted.
“It is because of this fact that I believe that we are currently in such a period where sustainable economic growth will be better achieved through holding rates constant. With this in mind I was disappointed that rates were raised by 0.50% last month.”

Copyright © Insurance Times and Investments® Vol:21.4 1st May, 2008
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