Oil prices threaten South Africa inflation target

If the rand were to hover around R6.40 to R6.50 to the dollar and the oil price were to sustain $60 a barrel for a year, and then South Africa would overshoot its inflation target range of 3 percent to 6 percent, according to Henry Flint, head of global markets research at Standard Bank.

To date the SA Reserve Bank has maintained that South Africa's inflation targeting regime is not in danger, but barring any unforeseen shocks to the local economy Flint's model suggests that consumer inflation less mortgage costs (CPIX) could rise to 7 percent and more. And oil at $70 a barrel for a year would push local inflation towards 8 percent.

In the year to date, the rand has weakened but averaged R6.31 to the dollar while the price of Brent crude has averaged $54.30 a barrel. But oil prices spiked again in August and have averaged $63.80 in the past two months.

Flint's model suggests that should this be sustained, bad news on the inflation front is coming our way in about 10 months.

Yesterday figures from Statistics SA showed annual CPIX inflation rose to 4.8 percent in August, a large leap from July's 4.2 percent.

Annabel Bishop, South African economist at Investec, said this was the result of the 27c a liter increase in the petrol price, base effects and the usual increase in household operations due to the rise in domestic worker wages.

She expected CPIX inflation would subside in the fourth quarter of this year providing that oil prices did not rise further and that the inflation target would be consistently achieved this year and next.

The other major risk to our well-maintained inflation targeting regime was food prices, according to Flint. Food prices are heavily weighted in the collection of factors that make up CPIX - making up almost 25 percent of the index.

"In the past we've had negative growth in food prices which absorbed the effects of the weaker rand and rising oil prices, but a turnaround is showing," Flint said.

Standard Bank's view was that maize prices would rise to trade at between R900 and R1 000 a ton. Yellow maize, at current levels, is trading at around R750 for December delivery and farmers are finding the prices unsustainable.

The maize price pushes food inflation by about 2.5 percent right now, but if it were to hit R1 000 a ton, food inflation would rise to over 3.6 percent.

Nonetheless, Flint expected the rand would be supported by a weakening dollar, strong commodity prices, improving local fundamentals and its popularity as an emerging market.

With the rand possibly mitigating the effect of higher oil prices, Flint, whose forecast was supported by Bishop, expected interest rates to remain flat well into next year.

"September's and October's CPIX figures will now be closely watched and we believe that the risk of a December 50 basis point interest rate hike is rising, given stubbornly high oil prices," Bishop added.

Source:  Business Report