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The Reserve Bank raises some interesting points in its monetary policy review, released earlier this month. Some of these are worth highlighting. One interesting discussion is on the influence of commodity prices on the rand. The bank’s conclusion that commodity prices have a strong influence on the real effective exchange rate, and to some extent on local economic growth, is not news, but it comes at an interesting time. The Commodities Research Bureau index moved largely sideways from May to August, but in September and October it increased by 1.9 percent and 3.3 percent respectively. Both are substantial jumps. «Probabilities are clearly in favour of a further rate cut in December». The most recent reading showed a 17.4 percent increase from a year ago. Our modelling of the rand confirms this view and the most recent rises in commodity prices point to further rand strength. Another interesting graph charted the Brent crude oil price. Ironically, the graph could not have been drawn at a more inopportune time, with the last update being Brent’s peak at $52 a barrel. Its has been back to $42, or nearly 20 percent lower. This is important for the bank’s inflation forecast, which shows CPIX (consumer price index excluding mortgage costs) increasing to a peak of around 5.5 percent in the third quarter next year. When asked what the main driver for this rise was, the bank’s response was «oil prices». So there have been dramatic changes since the review was published. Commodities are substantially firmer, supporting the rand, and oil prices are substantially lower. Both events, if sustained, will have a dramatic impact on the inflation outlook. Already we are looking to a cut in the petrol price of nearly 6 percent in December, a nice present for those taking to the roads at Christmas. This will more than offset the 3.6 percent increase in November and must reduce inflation expectations. This is new information the Reserve Bank’s monetary policy committee will need to consider at its meeting early in December. Lower inflation expectations are an essential ingredient for the committee to meet its targets. Bank governor Tito Mboweni has expressed concern over the level of credit extension to consumers and their expenditure patterns. These comments will add some caution to the rate cut debate, but in the context of a sharp downward revision of inflation expectations, the probabilities are clearly in favour of a further rate cut in December. Our own forecast for inflation struggles to find any drivers that can truly cause a test of the top of the inflation target band. In fact, based on a continued strong rand and stable oil prices at current levels, we believe CPIX will more likely drift to the lower part of the target band towards the end of 2005. In this environment, the risk is for lower interest rates. A sustained rebound in economic growth will be good for equities, an asset class that should continue to deliver good returns. At the same time, a lower inflation rate and reduced repo rate will be good for bonds. Consequently, we anticipate bond yields will continue to trend lower into early next year, providing good capital gains. Money market investments, on the other hand, will underperform. Inflation-linked debt will also underperform over a 12-month holding period, although there will be some nice returns early next year. By Leon Myburgh Leon Myburgh is the Africa strategist for Barclays Capital
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