A substantially stronger rand, declining food prices, falling services costs and authorised electricity rate increases that were lower than requested by Eskom are all likely to result in lower inflation than expected by the consensus this year.

With consumer inflation probably moving towards the middle of the target band in the first half of this year, the Reserve Bank may have the space to cut interest rates one more time. But the window is fast closing as developed countries are already considering how to withdraw unprecedented monetary accommodation this year. Our expectations are for consumer inflation to average 5.2 percent this year and 5.5 percent next year.

Eskom remains a concern

Although the 24.8 percent increase granted to Eskom by NERSA, before adjusting for specific criteria, is lower than the electricity provider requested, the general concern relating to its potential inflationary impact remains. However, this concern doesn?t take into account likely downside inflation surprises over the next few months.

The single most important development over the past year for the inflation outlook has been the rand?s appreciation. SA is a small, open economy and thus the currency plays a central role in determining inflation. Since March 2009, the trade-weighted rand has appreciated by 24 percent and is firmly in disinflation territory. Goods price inflation has responded materially, slowing from an annual advance of 12.5 percent in August 2008 to just 5.7 percent by January2010.

Goods inflation might slow

SIM calculates a PPI "finished goods" proxy that captures price changes in goods destined for end use consumption as well as finished goods used in the production process, for example machinery. Historically, this index has been a reliable indicator of changes in consumer goods prices. It?s not perfect, because the latter includes energy prices, which explains the divergence in recent months. But what the index does suggest is that goods inflation excluding energy should at least remain subdued, if not slow further, in the months ahead.

Part of the disinflation is a result of the lack of price pressures in the food pipeline. Indeed, food prices at the farm gate have collapsed relative to a year ago and there is no food price pressure evident at a manufacturing level. This suggests food prices at a retail level should also remain well behaved for some time to come.

Service inflation slowing rapidly

And, the disinflation story does not end there. Services inflation typically follows goods price inflation. Even though services inflation cannot be expected to collapse as it did in 2005, when domestic worker wages implausibly fell outright, the annual advance in services prices has slowed to 6.8 percent ? not far off the upper limit of the inflation target band ? from a peak of no less than 9.7 percent in July 2008.

On balance, the clear shift in momentum described above suggests consumer price inflation is headed for the middle of the inflation target range (4.5 percent) by May this year ? even if the vehicle emissions tax, petrol levy and excise duty increases and the Eskom tariff hike are taken into account.

One more cut?

Such an outcome may just prompt the Reserve Bank to cut interest rates again ? although admittedly the window of opportunity to cut is closing rather rapidly as growth accelerates and the global interest rate cycle bottoms.

Arthur Kamp is an Investment Economist at Sanlam Investment Management.