Residential market’s fortunes linked to food this year
“Early last year, we intimated that the residential property market’s fortunes in 2015 were strongly linked to oil. Early this year, it seems that food is a key commodity,” reports John Loos, FNB Home Loans household and property sector strategist, in the latest edition of the Property Barometer below.
Early in 2015, we expressed the belief that oil, and its major price slump, would be a boost to the fortunes of the residential property market, providing some support for an energy-guzzling world and domestic economy, while also contributing greatly to containing CPI (Consumer Price Index) inflation and thus the magnitude of interest rate hikes. We believe that this was indeed the case, although there was a host of other negatives, such as a simultaneous slump in many of SA’s export commodity prices, which prevented any strengthening in an already weak economy. Nevertheless, our economy and property market was far better off with low oil prices than what it would have been with high oil prices, had all the other things in 2015 turned out the same as what they did.
Drought and food significant
Starting 2016, it seems that the commodity on everyone’s lips is that of food prices and food production levels, and the news is not that good. Upward pressure on local food prices comes from two sources: firstly, the rand appears to be a key influence where domestic food prices are said to be strongly influenced by global food price levels. In dollarised terms, as at late last year, global food price levels appeared to have been behaving fairly well, with the IMF’s Global Commodity Price Index for food showing year-on-year deflation of -17.5% as at November 2015. While a seemingly positive development for South Africa, this rate of decline was far less than the -42.8% in the IMF Energy Price Index and the -30.3% year-on-year drop in its Metals Price Index. The result of this lesser food price decline was that it was insufficient to fully offset the impact of the rand depreciation over the period. And so, in rand terms, the IMF Global Food Commodity Price Index rose by +5.1%, whilst the Energy and Metals Price Indices actually dropped.
With the rand’s assistance, therefore, there appeared to have been some modest upward pressure on domestic food price levels from global sources insofar as global food price levels are an influence. Then, of course, there are the domestic influences on food prices in the form of a severe drought ravaging the country.
While not pretending to be an agricultural expert, the impact of the drought is reported to be severe, and what we do know is that the Producer Price Index (PPI) for agriculture had reached double-digits to the tune of 10.75% year-on-year by November 2015, having surged rapidly through last year from a deflation rate of -3% as at January 2015. This should be expected to exert upward pressure on the CPI inflation rate for food with a lag, which at November was still at a more moderate 4.8% rate. Given food’s significant weighting of 15.41% in the overall CPI, its influence on the overall CPI inflation rate can be very significant.
Therefore, the first two obvious impacts are a negative one on real household disposable income growth, caused by potentially higher overall CPI inflation, as well as on the cost of credit, due to the existence of an official inflation target, and the upward pressure that higher inflation can thus exert on interest rates. The latter impact is important for a residential property market that is highly credit-driven.
The risks posed by surges in food price inflation can go further, however. The reality is that South Africa currently experiences significant social tensions, which can be further fueled by a rising cost of living, especially for the low-income groups. Food is key here, because in the CPIs of the low-income/expenditure groups, food has a far larger weighting than the national average. Expenditure Quintile 1, the lowest expenditure group, has a weighting of as high as 39% in its own CPI. Food price surges can thus be devastating for the poor. In that this can potentially fuel social tensions further, which can in turn become disruptive to output of the broader economy should they manifest themselves in more extreme industrial action aimed at securing wage increases, it can be a further negative for economic growth, and thus household disposable income growth which is the purchasing power for homes.
The “social tensions risk” to economic growth is on top of the direct impact on GDP growth that a decline in agriculture sector output can cause. Agriculture’s Gross Value Add (GVA) in the 2nd and 3rd quarters of 2015 declined by a massive -8.9% and -16.2% year-on-year respectively, signalling a deep agriculture recession.
We estimate that this shaved off about a half a percentage point from SA’s already-poor GDP growth in the 3rd quarter, at a time when we desperately need more than the 1% year-on-year rate of that quarter, and at a time when the larger mining and manufacturing sectors are also battling to grow.
Admittedly, the key risk to residential property, from declining agriculture output, lies in the rural towns whose economies are very strongly dominated by agriculture production. But we can’t underestimate the potential risks of the drought to the broader national economy and residential market via the risk that it poses to food prices, inflation and thus interest rates, along with the contribution to slower overall economic growth.
The inconvenient reality is that everything hangs together. Thank goodness the oil prices, that other potentially big inflation driver, are behaving well.