The last reading of the 'old' CPIX went out with a bang on Wednesday as it instilled some hope of an aggressive loosening in interest rates locally.

From next month, a new consumer inflation series is upon us, with concomitant changes in what analysts will be looking for as the biggest change ushers in a move to Owners' Equivalent Rent – which measures the cost to owners of foregoing rental income by living in their properties.

It is generally expected that CPI is due to fall next year due to a lower weighting in both indices for food, but it is not known exactly by how much, with conjecture stretching from a potential 0.5 percent to 3 percent reduction in the private sector and some feeling it will be very marginal.

The current inflation target range of 3 percent to 6 percent in South Africa targets CPIX inflation, which excludes home loan costs. However, in the new CPI index to be published in February next year, home loan costs are replaced with OER.

But on top of this comes a healthy consumer inflation reading today, which is already seeing some bond investors making strong bets on a deep set of cuts.

The fourth monthly decline

Today's data shows the increase in South Africa's consumer price index excluding mortgage rate changes (CPIX) for metro and other areas, which is used by the South African Reserve Bank (SARB) for its inflation target, was up 10.3 percent year-on-year in December from 12.1 percent y/y in November. This is only slightly better than I-Net's Econometer forecast of 10.4 percent.

This is, however, the fourth monthly decline after the record 13.6 percent registered in August and is important for investors in the bond and money markets who are banking on rate soothing of at least 300 basis points.

Former Lehman Brothers lead economist on SA, Peter Montalto, who has now joined Nomura International, explains that the main surprise in today's reading was transport.

"Most of the downside surprise came from core which came in well below the 10.8 percent year-on-year expected at 10.2 percent. Of this the drop in vehicle running costs is what surprised us most, moving down more than would have been implied by the drop in petrol prices alone. It is the drop in fuel prices in level terms however which caused the sharp fall in the index overall from November."

"Food prices actually surprised to the upside coming in at 16.8 percent y/y. We had been looking for a small drop to 16.2 percent," he said.

A 50 basis point rate cut expected

Service prices increased by six percent and "remain sticky" at these elevated levels.

Overall, Montalto says, second-round effects from electricity price hikes during Q3 as well as strong wage growth are offsetting the influence of slowing growth to keep underlying inflation buoyant around 10 percent.

He also cautions that the central bank may be a little cautious prior to the release of the new index next month and that only a 50 basis point rate cut can be expected.

The reason is that the new index will have a greater emphasis on services, with his concern that electricity price rises and wages continue to filter through.

"Internally, they are still cautious about the new index as well as any possible shift of target in future," he says.

Today's data also showed that CPIX hit 11.3 percent in 2008 from 6.5 percent in 2007 and CPI struck 11.5 percent from 7.1 percent in 2007.

The Monetary Policy Committee will certainly have plenty to chew on over the next week before making their decision. Long-term bonds rallied 15 basis points today on expectations of strong rate cutting, and the market is now just a little wary as to exactly how intensive the rate cutting season will turn out to be.

The key is balancing current growth constraints and job losses versus inflation not dropping to below the target as comfortably and quickly as would be liked. Any signs of "stickiness" will be anathema for the central bankers.

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