Global Markets –
3rd quarter 2007 :Inflation –
a daily reality
We have all felt the
impact of rising prices recently,
most especially when filling up
at the petrol station or shopping
for groceries. This stands to reason
as food and transport costs are
the two largest components of the
"inflation basket", making
up 28.62% and 15.20%, respectively.
The next two components come as
no surprise – housing (11.57%)
and medical costs (7.70%). Naturally
every household has different levels
of exposure to these costs. Recent
statistics indicate that 73.7% of
South Africans have a household
income of less than R4 400 per month,
while almost 15% of these households
live on less than R2 000 per month.
These statistics go on to reveal
that only 6% of the population have
a monthly household income of more
than R19 974. According to Fraters
"the lower income households
are also likely to spend a proportionately
higher amount on food and transport,
the two components of inflation
that have shown the highest growth.
These two components are also at
the mercy of supply side dynamics,
and consumers are forced to buy
the same quantities, no matter what
the price."
It is reported that in 2006 less
maize was planted following the
maize surplus in 2005. Unfortunately,
unfavourable weather conditions
impacted on the maize harvest, resulting
in the current maize shortage. And
typically, a shortage in supply,
translates into greater demand and
higher prices. The price of maize
has also risen internationally as
maize is now being used in the production
of bio-fuels. While food and fuel
prices are high up on the list of
culprits, we must remember that
supply and demand factors also impact
on inflation. By way of example,
recent wage disputes have resulted
in settlements for annual increases
at levels above inflation. In terms
of the "supply" side,
uncontrollable factors such as the
weather and world prices have impacted
negatively on the price of raw materials
and fuel. All these factors contribute
to inflationary pressure.
We know that inflation has breached
the upper target (6%) for several
consecutive months, and this has
become a cause for concern. Consequently,
the Reserve Bank have again raised
interest rates at their June and
August meetings. The latest inflation
figure came in at 6.5%, which is
higher than the projected 6.2%.
What can be done to curb this rising
trend in inflation? The answer to
this type of question is never simple
because there are so many factors
at play. According to a recent article
published by Fraters, "for
overall inflation to decline in
an environment where food and fuel
prices are rising faster, we need
the rest of the basket to show some
price declines." Consumer spending
also needs to slow further. The
environment of higher interest rates
and the new stringent requirements
put in place by the National Credit
Act in June should put a dampener
on spending. In the meantime, there
is already evidence that consumers
are starting to feel the pinch and,
as a result, are likely to think
twice about increasing their already
onerous debt levels. In turn, slower
domestic demand should serve to
moderate price pressures. However,
we may not have turned the corner
just yet. It looks like we may well
be in for another interest rate
increase in October based on the
disappointing inflation and producer
numbers released at the end of August.
Source: Fraters quarterly
report – 2nd quarter of 2007
and various publications
REGIONAL
COMMENTARY
UNITED STATES OF AMERICA |
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The Federal Reserve kept interest
rates unchanged at 5.25% during
the quarter under review. This is
the ninth consecutive meeting over
a thirteen month period that rates
have remained level. Commenting
after the announcement, the Federal
Reserve stated, "financial
markets have been volatile in recent
weeks, credit conditions have become
tighter for some households and
businesses, and the housing correction
is ongoing." Their statement
went on to state that" although
the downside risks to growth have
increased somewhat, the Committee's
predominant policy concern remains
the risk that inflation will fail
to moderate as expected." However
they expect the economy "to
continue to expand at a moderate
pace over coming quarters, supported
by solid growth in employment and
incomes and a robust global economy."
Economists are divided as to whether
the next move in rates is likely
to be up or down. The prevailing
view is that the next move could
well be down, but that this is unlikely
to happen anytime soon. Second quarter
GDP figures have been revised up
to 4%.
Concern over credit in the US, particularly
in the US sub-prime mortgage market
which led to the re-pricing of risk
in the credit markets, sparked volatility
during the quarter. "Sub-prime
mortgages are higher-interest loans
given to higher-risk borrowers or
those on low incomes." Consequently,
sustained periods of "high"
interest rates are likely to impact
on these borrowers first. In a surprise
move on the 17th August, the Federal
Reserve "cut its primary discount
rate, which is the rate at which
it lends money to banks, from 6.25%
to 5.75%." Commenting after
the announcement the Fed stated,
"financial market conditions
have deteriorated, and tighter credit
conditions and increased uncertainty
have the potential to restrain economic
growth going forward." The
Federal Funds Rate has remained
unchanged at 5.25%.
After raising interest rates to
4% in June (in line with expectations),
the European Central Bank (ECB)
left rates on hold for the remainder
of the quarter under review. The
latest increase takes rates to their
highest level in 6 years (after
doubling in the last 18 months).
Commenting after the July meeting,
Jean- Claude Trichet said, "our
monetary policy is still on the
accommodative side, with overall
financing conditions favourable,
money and credit growth vigorous,
and liquidity in the euro area ample."
The market still expects further
rate increases in the region later
this year, which have been reinforced
by ECB President Jean-Claude Trichet's
promise of "strong vigilance"
when it comes to dealing with inflation.
Despite inflation currently being
below the 2% target at 1.8%, robust
growth in the region is likely to
put upward pressure on inflation.
Strong credit demand by the private
sector remains an area of concern
for the ECB, with recent statistics
indicating that loans in this sector
have increased at their fastest
pace since December 2006 –
up by 10.8% for the one year to
June.
The Bank of England (BoE) increased
interest rates by 25 basis points
to 5.75% at their July meeting after
commenting that "most indicators
of pricing pressure remain elevated."
Rates remained unchanged at the
August meeting of the BoE, bringing
an element of relief to borrowers
who have experienced 5 interest
rate hikes in the last year. Senior
economist of the EEF (the manufacturers'
organization), Lee Hopley, welcomed
the August decision to leave rates
on hold, saying that "given
some evidence that the Bank may
already have done its job, rates
should now be left where they are
until a clearer assessment can be
made of the direction of the economy."
David Kern, economic adviser for
the British Chambers of Commerce
agreed, saying "we remain very
concerned that the markets still
expect an increase in rates later
in the year. There are already signs
that the housing market is softening.
The slowdown in average earnings
growth strengthens further the case
for waiting." He went on to
add that "disposable income
growth is at record lows and savings
levels are also very low."
In mid August, the July inflation
figure came in at 1.9%, which was
well ahead of expectations and significantly
better than the June number of 2.4%.
Inflation has stubbornly remained
above the 2% target level and this
is the first time since March 2006
that it has dipped below 2%. Commenting
on this good news, Howard Archer
of Global Insight said, "this
is a massive surprise. Consumer
price inflation fell back far more
than anyone was expecting in July,
including, we strongly suspect,
the Bank of England. This will boost
expectations that interest rates
have peaked at 5.75%, especially
as the current turmoil in global
credit and financial markets further
dilutes the case for higher interest
rates, at least for now." According
to a BBC report "the lower
cost of food – from bread
and cereals to meat, fish and fruit
– was the biggest contributor
to the surprise fall in consumer
price inflation as supermarkets
slashed prices to compete for market
share." Lower energy bills
and discounts offered by furniture
retailers also added to the lower
than expected inflation number.
In the same report the Office for
National Statistics has warned,
however, that the recent flooding
could "cause supermarket shortages
in the run-up to Christmas, which
would in turn push up the price
of food, particularly vegetables
and milk" Before this data
become available, it was widely
expected that interest rates would
rise to 6% by year end.
In line with their forecast, Nationwide
have reported that growth in house
prices "stalled" in July,
and is a sign that higher interest
rates are starting to impact on
buyers. It is reported that the
annual rate of growth declined to
9.9% in July from 11.1% in June.
Commenting on the slowdown, Fionnuala
Earley – the chief economist
for Nationwide, said "the sharp
slowdown in July's house price numbers
could show that potential homebuyers
are thinking twice about overstretching
themselves in a higher interest
rate environment."
The Bank of Japan (BoJ) left interest
rates unchanged during the quarter
under review, having last increased
rates from 0.25% to 0.50% in February.
The market had expected rates to
rise again in August, but the BoJ
elected not to do so in the "wake
of recent turmoil in financial markets
worldwide", a BBC article reported.
In addition, economic growth figures
for the second quarter to June came
in below forecasts at 0.1%, compared
to the market expectation of 0.2%,
primarily as a result of "lacklustre
exports". Rates are still expected
to rise later this year, but at
a gradual pace, due to the fact
that inflation is still non-existent
in the region.
Unemployment in Japan recently recorded
9 year lows. As highlighted in our
last report, improving employment
levels are having a positive impact
on consumer confidence, and as a
result, an improvement in consumer
spending is becoming evident.
At the end of July, Prime Minister
Shinzo Abe's ruling partly lost
its majority in the upper house
following the first "nationwide
electoral test since he took office
10 months ago pledging to boost
Japan's security profile and rewrite
its pacifist constitution."
According to a recent article by
Reuters, "Abe's coalition will
not be ousted from government by
a loss in the upper house, since
it has a huge majority in the more
powerful lower chamber, which elects
the premier. But with the main opposition
Democratic Party of Japan on track
to become the biggest party in the
chamber, laws will be hard to enact,
threatening policy deadlock."
In line with expectations,
the Reserve Bank (SARB) raised domestic
interest rates at both meetings
during the quarter under review.
As a result, the Prime Lending Rate
and the Repo Rate have increased
to 13.5% and 10%, respectively.
The latest increase is the sixth
interest rate increase since June
last year, with rates having risen
by 3% in the current tightening
cycle. Although the latest announcement
was widely expected, it was received
with some criticism in light of
the market turmoil which is attributed
to the sub-prime mortgage market
in the US. According to Colen Garrow,
chief economist at Brait, "I
think the decision is one that introduces
negative risks. I think it shouldn't
have been about adjusting rates
today – there may have been
a more appropriate time to hike
rates. The key central banks are
standing by their markets by providing
support, but today's decision doesn't
do that for South Africa."
Stats SA reported in late August
that GDP growth for the second quarter
came in at 4.5% (quarter-on quarter)
compared to 4.7% in the first quarter
of 2007. It is reported that the
business services industry, finance
and real estate were the main contributors
to growth in the second quarter.
The July inflation figure of 6.5%
year-on-year, announced at the end
of August, came as a nasty surprise.
Most analysts had expected a figure
of 6.2%, which is slightly below
the 6.4% recorded in June. The July
Producer Price Inflation (PPI) figure
was also disappointing at 10.3%,
which is marginally better than
the 10.4% level recorded in June.
The market had expected this number
to come in at below 10%. As a result,
there is now a strong likelihood
of another 50 basis point increase
in interest rates in October..
GENERAL – OIL AND GOLD
The oil price remained volatile
during the quarter under review,
ending the period at $72.20 a barrel,
compared to $67.89 a barrel at the
end of May. During the quarter under
review, the price reached $78.77
a barrel, following continued concerns
about disruptions to supply particularly
in the North Sea and in Nigeria.
Adding to these supply concerns
was the worry that demand could
well outstrip supply by the end
of 2007. However, prices declined
in early August. Commenting on the
price decline, Gerard Burg, an oil
and gas analyst from the National
Bank of Australia, stated "the
sell-off was continued from Friday
and largely due to the decline in
the US financial markets. Some investors
may have taken risk adjustments
and are selling out of liquid commodities
assets to cover commitments in other
markets. Apart from the US factor,
there are no major fundamental stories
dragging down prices." Goldman
Sachs have indicated that they expect
demand for oil to remain the same,
and that this demand will be driven
largely by emerging markets.
The gold price experienced periods
of volatility during the quarter,
ending the period at $673.25 an
ounce, compared to a close of $660.55
at the end of May. Typically when
there is an element of market volatility
(as was the case during the quarter)
investors tend to move towards gold
as it is seen as a "safe haven".
It is worth noting that investors
don't appear to have done so this
quarter, with risk aversion in the
equity markets also spreading to
commodities.
CONCLUSION
We are pleased to confirm that the
presentation by Sarasin to clients
of Finlaw will take place at the
Redlands Hotel on Thursday the 20th
September. The seminar will start
at 17h00 for 17h30 - invitations
were mailed out on the 20th August.
Should you wish to invite a guest
to the presentation, please let
us know by the RSVP date detailed
on the invitation.
Finally, a reminder about the deadline
for the submission of personal income
tax returns, which is 31 October
2007.
QUARTERLY QUOTE
"The human race has one really effective
weapon, and that is laughter"
Mark Twain
This report
is based on information sourced
from various institutions, both
local and international. The report
reflects a variety of views and
is not intended to convey investment
advice. Please consult us to obtain
specific advice relevant to your
investment portfolio.
