An Update on Inflation

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The inflation numbers to the end of January came out yesterday in line with market consensus at 3.7%. This number is still on the low end of the 3% - 6% that the Monetary Policy Committee (MPC) targets, which could result in investors, and citizens alike, thinking that we don’t need to be worried about inflation for the foreseeable future. While I don’t think that we are at risk of runaway inflation, there are some important issues that everyone should be aware of going forward.

Firstly, we are STILL seeing many sectors of the economy demanding (and striking) for wage hikes in excess of 6%. Over 65 000 truck drivers are the latest to go on strike, with their demands for a 10% wage hike per annum for the next 2 years – and now willing to take 9%. Without going into the discussion of whether they are earning a fair wage for what they do – this is always a contentious debate – a 10% wage increase should rationally only be given by their employers if the drivers had improved their productivity by at least 4% over the year.

Rationally, for an employee with no change in job description, his/her wage increase should be inflation plus or minus the change in his/her productivity. Any increase in excess of this amount leads to inflationary pressures, while any increase less than this amount would result in the employee losing purchasing power.

Ultimately wage increases structurally above the current (and targeted) inflation level will be inflationary as the business owners will, at some stage, need to pass the increased costs onto the end consumer.

Secondly, the inflation rate of food and non-alcoholic beverages looks like it’s on an upward trajectory. At the moment it isn’t having an impact on the total inflation number as it is only 3.1% for the 12 months to January 2011, but in January alone it was 2.2%! With this component of the basket compromising nearly 1/6 of the total basket, we can expect to see it having a bigger impact on the inflation number going forward.

Thirdly, and related to the above point, is the cost of fuel. Petrol was up 3.4% in January, and we know that it is going to be up again in February, and most likely in March. The tailwinds to the inflation number towards the end of 2010 of a lower oil price, and stronger rand have disappeared. We think that there is a higher probability that the rand will be weaker than current levels and oil will be more expensive in US$ at the end of the year than the other way around.

While petrol only contributes 4% to the inflation basket, the second round affects are a lot bigger – i.e. cost of food goes up because it costs the farmer more to farm his land and deliver his produce, etc.

Investors should be aware of these risks. With South Africa being a small open economy, we are very susceptible to inflation shocks, and should therefore factor this into our decision making process.

Take care,

Mike Browne
info@seedinvestments.co.za
www.seedinvestments.co.za
021 9144 966

Thu, 17 Feb 2011

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