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CPI plunge gives Bank scope to slash rates

Economists divided as inflation risks and rand volatility create concern
Economics Correspondent
THE consumer price index (CPI) plunged to its lowest level in 44 years last month, with domestic inflation now lower than most of SA's main trading partners, but local interest rates still far higher than in other major economies.
Headline CPI slowed to 0,4% year on year last month, while the Reserve Bank's targeted inflation measure, CPIX (CPI less mortgage costs), was at a record low of 4,1%, prompting speculation that interest rates will be cut further in February, despite the Bank's cautious stance last week.
The Bank surprised the market last week by cutting its key repo rate by a lower-than-expected 0,5 percentage points to 8%, citing rising domestic demand as a threat to the 3%-6% inflation target in 2005.
Absa treasury economist Chris Hart said there was scope for a rate cut of one percentage point in February, since local interest rates remained fairly high compared with SA's major trading partners, while the inflation rate was below those of trading partner countries.
Inflation in the rest of the world is fairly subdued, with the US inflation rate at 1,8%, UK at 2,5%, Europe at 2,2% and Japan's at 0%.
However, the Bank's repo rate far exceeds key central bank rates in these countries, with rates in the US at 1%, Europe 2% and the UK 3,75%.
"The (Bank) has unfinished business from (last week's) meeting. We may see CPIX even converging with our major trading partners. The rand influence (on inflation) has been quite strong, and with further weakness in the dollar forecast for next year, we could see the rand remain reasonably strong," Hart said.
The rand fell sharply yesterday on rising import demand and profit-taking after its strength in recent weeks, while thin trading volumes increased volatility.
The rand weakened to R6,5455 to the dollar from its previous close of R6,3665, but settled to trade around R6,4975 later in the day. The currency also plunged against other major currencies, weakening to R8,0459 (R7,8559) to the euro and R11,4403 (R11,1788) to sterling.
Economist Noelani King Conradie said the main risk for inflation in future was a weakening of the rand, echoing the concerns of the Bank, which said last week that it was "impossible to predict" the exchange rate in the coming months.
"At this stage, we would argue rates should not be cut further and remain stable. This is based on the view that inflation could start moving higher in the months following the February (monetary policy committee) meeting.
"Especially in an inflation- targeting environment, rates cannot be cut further when there are signs inflation has bottomed," she said.
Rising food prices, which are putting upward pressure on inflation, may also cloud the outlook for interest rate cuts next year.
Food inflation increased 3,2% year on year last month, up from 2,8% growth in October, fuelled by dry weather and rising international grain prices.