Inflation - an investment risk often overlooked

06 April 2011

 

Marize Pieters, Investment Analyst, Glacier by Sanlam

 

The newly released inflation figure (CPI unchanged at 3.7% y/y) was in line with market expectations, but has surely surprised the man on the street. With the latest hikes in the price of petrol still fresh in consumer’s minds, food prices creeping up once again and further increases in sin taxes and petrol levies announced at the national budget, consumers are feeling the burden of higher inflation on their pockets.

 

With South African interest rates at their lowest level since 1974, bringing the repo rate to 5.5%, a cash investment is returning a meager positive real (after inflation) return. Given looming inflationary pressures, with inflation expectations on the rise, cash will probably deliver negative real returns in future if interest rates are not hiked in conjunction with rising inflation.

 

If one considers the forward yield curve the market seems to be pricing in the first interest rate hike in Q4 of 2011. There are however different views in the market.  Some economists are forecasting interest rates to only be hiked in 2012 given the obvious risks to economic growth. 

 

Even though economic growth in South Africa picked up during 2010, when compared to 2009 it remains sluggish. The high unemployment rate (24%) and elevated debt levels of consumers remain a threat to future growth. It therefore comes as no surprise that in the latest budget speech by Finance Minister, Pravin Gordhan, there was a strong focus on job creation and an acknowledgment that high unemployment remains a major threat to sustained economic growth.

 

The South African Reserve Bank’s (SARB) primary focus, of price stability and inflation targeting (3% - 6%), is also being challenged. Under the new reign of Governor Gill Marcus the SARB might be facing a dilemma on whether to shift its primary focus from price stability to one of economic growth and job creation or possibly a combination thereof. With 2011 declared a year of job creation by SA’s President, Jacob Zuma, in the ‘State of the Nation Address’ and reiterated by Pravin Gordhan, it is still unclear how the SARB will continue to implement its monetary policy mandate as it should surely support the priorities of the South African government for 2011 as well. 

 

The debate regarding the independence of the SARB will without a doubt continue in the months ahead, whilst particular attention will be given to developments on the economic front and the creation of new jobs in South Africa. One can therefore not help but wonder if interest rate hikes will be slower than anticipated, which may result in cash delivering negative real returns in the short term if inflationary pressures continue to persist.

 

Whilst the thought of capital preservation and interest earned from cash may seem attractive to many investors they should not be fooled by an investment that hardly keeps up with inflation. Inflation has a diminishing effect on purchasing power which means your R100 today won’t be able to buy the same basket of commodities in a year or two.

 

It is therefore critical that investors are rewarded with inflation beating returns at the very least should they want to maintain their standard of living. However, investors unfortunately often disregard inflation as a major threat to their investments when they are ‘safely’ stowed away in cash. Many investors often do not realise the devastating effects of a poor investment decision today on their ability to retire one day. One which could essentially make them poorer by the day.