Like it or not, inflation is now back with us

PUBLISHED : Wednesday, 23 June, 2004, 12:00am
UPDATED : Wednesday, 23 June, 2004, 12:00am

TIME TO PLAY GAMES with numbers. Bear with me here because what these numbers suggest is that our inflation rate is already rocketing upwards rather than still showing a decline from a year earlier as the May consumer price index report would have us believe.

We shall start with what the CPI report says is inflation in housing. This is the red line in the first chart and I have shown it here as an actual index rather than as a percentage year-on-year change figure derived from that index. I have also rebased the index to a value of 100 for May last year.

As you can see, there was an up-and-down blip in this index in the middle of last year, mostly the result of a change in rates, but the track is otherwise straight down and the decline is a steep one. It says that average housing costs were 6.75 per cent lower last month than they were a year before.

Now this, as you know, stands contrary to what the property market has been doing since May last year. Property prices have risen by at least 25 per cent over this period. What gives?

There are two things to note here. The first is that the CPI does not track property prices. It only tracks property rents. If you think this odd, you are not alone but there are indeed good reasons why it is hard to incorporate property prices in an inflation index.

Answer just a simple question to recognise one of those difficulties. If you are already a homeowner, do your housing costs go up when property prices go up?

Obviously they do not. They only do so if you are still paying off a mortgage and your interest rate on that mortgage goes up. This, however, is a different matter. There are other difficulties with tracking property prices for a CPI and the upshot of them is that most jurisdictions track rents as a proxy.

The second thing to note is that the CPI is not concerned with the most recent change in rents on the market. Neither are you if you have just signed a two-year lease and rents go up. Your rent is already fixed for the term of your lease. It is what people actually pay in rents that the CPI tracks and thus it considerably lags what is actually happening at the leading edge of the market.

To see what a difference this makes, look at the blue line in the first chart. It represents the Rating and Valuation Department's index of the most recent changes in property rents and, rather than that 6.75 per cent decline registered by the CPI, it says average housing rents have risen 4.8 per cent over the last year. Now turn to the second chart. The red line here represents the overall CPI, with the base of this index once again changed to a value of 100 for May last year. The first thing to note here is the steep Sars-related drop in consumer prices from April to July last year. Over those three months alone, prices dropped by almost 2.8 per cent, an annualised decline of 11.2 per cent, which is very steep indeed.

Then note that the bottom was reached in August last year, and since that time, prices have generally been up. This is not yet reflected in the year-on-year change number for the CPI for the simple reason that the base figure of one year earlier has not yet tumbled all the way down that slide in the index from April to July last year.

So here is the first game with numbers. Think of what the year-on-year rate of inflation will be in August when we are comparing the latest figure with the bottom of the slide.

To get back to inflation from deflation with a positive change number for the first time in almost six years will not require that prices rise at all over the next three months. The change in the base period alone will do the trick. And here is the second game with numbers. Let us substitute the Rating and Valuation Department's rental index for the one at present incorporated in the CPI. The blue line in the second chart represents the result of doing this. Our year-on-year rate of inflation in May would already be a positive 2.3 per cent.

Yes, that may be overstating things but it will not be so for long. Count on it that inflation is already back with us. I am not sure it is an entirely welcome prospect.