In January 2002, the SA Reserve Bank surprised the markets with a 1% increase in the Repo Rate. In line with expectations, the Monetary Policy Committee increased interest rates by a further 1% at their meeting in March 2002. The main factors contributing to this increase were: the expectations of increasing inflation caused by the sharp deterioration of the Rand in December 2001, domestic expenditure exceeding national disposable income last year – and this is expected to continue, the acceleration in the money supply and finally, the sharp increase in nominal unit labour costs.
The question now foremost on everyone’s’ minds appears not to be whether there will be another interest rate hike in June, but how much this increase is likely to be. Tito Mboweni, Governor of the Reserve Bank, has made it clear recently that he favours an increase of at least another 50 basis points – the current view in the market place, however, is that the increase is likely to be another 75 to 100 basis points.
The inflation data for April, which once again reflected the lagging effects of the Rand’s dramatic decline last year, has made a strong case for another interest rate increase, especially in light of the fact that Government has announced its intention to link public servant salary increases to CPIX inflation. This stance has sparked concerns that this may serve as a precedent to the private sector – bringing about secondary inflationary pressures. Producer inflation rose to 14,8% year on year in April, from 14,1% in March, while CPIX rose to 8,8% year on year in April, from 8% in March. In April, headline CPI rose to 8%, from 6,6% in March.
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| Source : African Harvest |
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Source : African Harvest
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Escalating food prices remain the main contributor to inflation, having contributed more than 40% to the increase in prices over the past year, as measured by the CPIX. Other major contributors have been housing and transportation costs. The sharp escalation in producer food inflation has led to a sharp rise in consumer food inflation – having risen from 3,2% in June 2001 to just on 15,1% in April 2002.
As mentioned in our previous newsletter, the inflation pressures caused by the fall in the Rand at the end of last year are expected to take some time to work themselves out of the PPI and CPI numbers. Tito Mboweni has often stated that the only weapon available to the Reserve Bank to curb inflation is the interest rate mechanism. Having said that, there seems to be little doubt, after having reviewed the facts at hand, that a further interest rate increase of 50 to 100 basis points may well be on the cards.
We now take a look at some of the major economic regions around the world.
The Federal Reserve changed their view from “easing” to “neutral” in March, and in line with expectations, kept interest rates on hold at their meetings in March and May 2002. In the words of one economist “This is a Fed waiting to see the whites of the eyes of recovery”. While the Fed is due to meet again on the 25th and 26th June, they are not expected to increase rates until after August. One of the main reasons cited for this view is that corporate America is currently highly leveraged and that an increase in interest rates at this stage would impact severely on corporate profits. Rising unemployment, which will undoubtedly impact on consumer spending, is yet another reason for the Fed to leave rates as they are. Consumer spending fuels two thirds of the American economy.
The current environment of moderated inflation and increased first quarter productivity (which increased by the highest level in over 19 years) should allow corporate profits and the economy to grow without increasing costs – however, this increased productivity has been largely at the expense of employees. Companies have been reluctant to hire new employees until they are comfortable that the recovery is sustainable.
First quarter GDP grew better than expected, at 1.5%, compared to 0.90% during 2001. So, while an economic recovery appears to be underway, we are likely to witness more modest growth levels. This can be attributed, in part, to a weakening US Dollar and the fact that corporate profits remain sparse.
It is encouraging to note that many analysts are of the opinion that a recovery is becoming more apparent in this region. Some of the factors driving their optimism include the fact that business confidence appears to be improving (with the exception of Germany), together with the tax and pension fund reforms that have been implemented.
If the recovery in industrial activity results in the region resuming its long-term growth trend and inflation remains under control, then there should be no need for the European Central Bank to increase interest rates sharply at this stage. In the event of this scenario materialising, it is anticipated that key interest rates (currently 3,25%) will be increased gradually to reach 4% by year-end. However, the European Central Bank still has scope to reduce interest rates by a further 25 basis points by mid year, should the recovery prove to be slower than anticipated. The main factors contributing to a slower recovery include lacklustre consumer spending, weak investment levels and the long-term potential of the region being countermined by the slowness of reform. Other factors to monitor are the political issues that have been raised as a result of the recent elections held in Germany and France.
The Euro has strengthened by some 8,17% against the US Dollar since my last report, ending the quarter at 0.9395 (at 31 May 2002) from levels of 0,8685 on 1 March 2002. If the US Dollar continues to weaken, it is likely that the Euro will reach parity to the US Dollar by the end of this year.
A weak economy continues to plague Japan, together with high levels of government debt, falling asset values, a banking system in crisis and reforms that have been slow to materialise. Having said that, a lot of this negativity appears to have already been factored into the markets. In addition, for the first time in five quarters, the Ministry of Finance has upgraded its assessment of the Japanese economy, while the weak Yen has continued to support exports. Both business and investor confidence appears to be on the increase in Japan.
A growing number of analysts are becoming cautiously optimistic about Japan – essentially viewing this region as high risk / high reward. While we agree that many factors are turning around for this region, we continue to remind investors that the extent of an economic turnaround in Japan is largely dependant on the high gearing of the Japanese economy to the pick up in global growth.
Despite having cut interest rates seven times last year, the Bank of England left interest rates unchanged at their last meeting (rates are currently at 38 year lows). Analysts continue to expect moderate growth from this region, however, the possibility of higher interest rates, together with higher levels of debt may cause consumer spending to decline. Exports from the United Kingdom should receive a welcome boost from economic growth in Euroland and the United States of America. The growth rates for 2002 have recently been revised upwards by the Chancellor of the Exchequer – from 2,5% to 2,5% – 2,75%.
The most notable development since my last report has been the strengthening of the Rand. After falling some 37% last year (testing levels of R13,85/$ in December), the Rand has managed to retrace approximately 19% against the US Dollar. One of the benefits of the sharp fall of the Rand was that it provided domestic exporters with a much needed boost, however, it triggered a domestic inflation spiral – the effects of which will be with us for some time to come. It is expected that CPIX may reach levels of 10% during the last quarter of 2002.
The recent recovery of the Rand can be attributed to several factors, including the fact that news from Zimbabwe no longer makes the news (although very little appears to have changed), Government is committed to fast tracking the privatisation initiative – the proceeds of which will go a long way to reducing the Net Open Forward Position, the dramatic turn around by Government on the HIV / AIDS policy, renewed interest by foreign investors in our markets (approximately R7,14 bn was invested between January and April 2002), Trevor Manuel alluding to the gradual liberalisation of exchange controls and of course, the publicity received as a result of Mark Shuttleworth’s recent trip into space.
US Dollar appreciation against the SA Rand – 60 months to 31 May 2002
Oil continues to be the unpredictable factor in the global economy. The main factors driving the oil price include the unrest in Venezuela together with the mounting tensions in the Middle East. Oil is currently at 23,75 $ per barrel.
With international markets over the past five months attempting to retrace some lost ground, this has, once again, highlighted the importance of portfolio diversification
“Experience is the hardest kind of teacher. It gives you the test first and the lesson afterward.” Unknown
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.
