Falling CPI hides a worrying trend from public eye
October 1, 2009
By Ettienne le Roux
A closer look at the most recent consumer price index (CPI) data reveals that all is not as it seems. Beneath positive headline inflation trends lie two diverging developments - the one good, the other bad.
At first glance, the statistics make for pleasant reading.
CPI inflation moderated to 6.4 percent year-on-year in August from 6.7 percent in July, and a peak of 13.6 percent twelve months ago. When breaking down the headline number, similar encouraging trends emerge. Consumer inflation across all expenditure groups is easing. Even in rural areas, where inflation tends to be stickier, price increases are slowing nicely.
The reason why CPI inflation has more than halved over the past year, irrespective of expenditure group and geographical area, is a slump in goods inflation.
Benefiting from favourable weather conditions, lower input costs and a strengthening rand, food inflation has fallen sharply from high double digit growth last year to 6.1 percent in August.
At the same time, in strongly competitive markets, worsening sales have resulted in lower price increases, or in cuts, as retailers slash unwanted inventory of semi-durable and durable consumer goods.
For instance, inflation for household contents and related products has eased from 8.5 percent a year ago to 6 percent in August, while prices of household furnishings, textiles and items such as second-hand cars, have been falling for a while.
But even though goods inflation has decelerated strongly, CPI inflation has fallen less rapidly. The hindrance: high and accelerating services inflation.
In contrast to the goods people regularly buy - such as food, petrol and clothes - services are mostly intangible and are obtained less frequently, for example insurance policies, school fees and TV licenses.
As services are not as much in the "public eye", consumers often forget about services inflation as something that continuously chips away at their income. Services account for 46 percent of the CPI basket, so are almost as important a driver of consumer inflation as goods, which make up the remaining 54 percent.
So, while the public is benefiting from falling goods inflation (hooray), the reverse is true for services (sulk).
After averaging 7.3 percent over the 2007 and 2008 period, services inflation is back above 8 percent with little to suggest the rising trend is about to end, bearing in mind rising electricity costs, water tariffs and assessment rates.
Besides the headline number, which is unacceptably high, a detailed look at the services basket itself reveals some alarming developments. In December 2006, roughly 70 percent of the broad service categories had year-on-year inflation rates below 6 percent. Two years later, this ratio dwindled to about 45 percent. In August, only 30 percent of services had inflation rates less than 6 percent.
Most disconcerting is the fact that more than half of the 70 percent of services with inflation rates above the upper limit of the CPI target band are currently running double-digit growth rates. Against this backdrop, it is not surprising that most core measures of consumer inflation (CPI excluding food and other volatile goods) remain stuck at roughly 8 percent and this is occurring almost two years into a severe economic downswing.
Theory tells us that a contraction in domestic expenditure, such as we are experiencing currently, shifts the demand curve to the left. With the supply curve static, a move of this nature would lead to lower inflation as inventories rise. Such dynamics are playing out in the case of numerous durable and semi-durable consumer goods, although to varying degrees.
Even in selected services, theory is working as it is supposed to. For instance, rentals that account for a third of the CPI services basket, have seen a sharp downturn in inflation as the recession and associated property market slump have resulted in rising vacancies. But market forces can only work properly in a strongly contested environment, which is largely non-existent in the case of many services.
The Competition Commission is hard at work investigating alleged cartels and monopolistic price fixing. But perhaps part of the commission's job should also be to find ways of ensuring greater competition in the services industry.
As the single supplier of many services, this means that the government would have to be scrutinised. High and rising services inflation is keeping CPI inflation and, by implication, interest rates higher than ought to be the case. What a pity.
Le Roux is chief economist at Rand Merchant Bank
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