Inflation increase not expected to affect repo rate decision

The uptick in inflation for August is not expected to affect the decision about the repo rate on Thursday, with economists expecting the rate will remain unchanged. The inflation rate increased from 4.7% in July to 4.8% in August.

Economic research group, Oxford Economics Africa, says the August inflation print was in line with expectations and shows that favourable base effects have now largely run their course. The outcome was marginally lower than the group’s expectation of 4.9% and in line with the consensus forecast of 4.8%.

The group expects that the South African Reserve Bank (Sarb) is likely to keep the repo rate unchanged at 8.25% during the upcoming Monetary Policy Committee (MPC) meeting although inflation moved further away from the midpoint of the Sarb’s target band of 3%-6%.

“The weak rand exchange rate and higher international oil prices pose a risk to South Africa’s near-term inflation outlook,” the group warns.

The sub-component for fuel price inflation increased by 2.2% month-on-month in August and the pace is expected to quicken in September after the price of petrol increased by 7.5% and diesel by 14.1% compared to July.

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Another sizeable fuel price increase is anticipated for October. The group says the main driver for the recent surge in Brent crude prices is the decision by Saudi Arabia and Russia to extend their production and export cuts to the end of 2024.

“This unilateral action by the two producers comes on top of Opec+ cuts and will tighten the oil market further. We now expect Brent to average $83.1pb in 2023 and $84pb in 2024.”

Other factors that will affect inflation

Meanwhile, the group says, the rand remained on the back foot since its sell-off earlier this year. “We forecast the rand exchange rate to average R18.4/$ in the second half of 2023, compared to the R18.2/$ averaged during the first half.

“High fuel prices in general and diesel specifically will stifle economic activity in the second half of the year and feed into higher agricultural input and transport costs, with South Africa’s 2024 cereal crop planting seasons set to start in October 2023.

“Low-income households in particular are expected to suffer as a consequence of high living costs. Although food inflation eased in recent months, this has mostly been due to favourable base effects. Considering the damaging effects of load shedding, average food inflation is likely to settle above pre-pandemic levels in the short term. The potential impact of El Niño remains a latent risk at this stage.”

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The group says headline inflation is expected to oscillate around the upper end of the inflation target band over the coming months as prices get stickier, owing to a weak rand exchange rate and a series of domestic fuel price increases keeping inflation elevated.

“Monetary authorities are likely to hold interest rates higher for longer and we do not expect the Sarb to cut interest rates ahead of the US Fed, which should start to slash rates in the second quarter of 2024. Having said that, further rate increases by the Sarb this year cannot be ruled out at this stage. We forecast inflation to average at 5.8% in 2023,” the group says.

Inflation expected to drift upward

The Nedbank Group Economic Unit also expects inflation to drift slightly higher in the coming months as the base effect dissipates. “Upward pressure will stem from moderately higher fuel prices, rising operating costs due to Eskom’s electricity tariff hike and the return of severe load shedding and continued rand weakness.”

The unit’s economists say food inflation will moderate further off a high base, kept in check by generally subdued global food prices and shrinking domestic demand.

“However, the rate of deceleration will probably bottom out as the global price cycle gradually turns with spikes in selective food products due to unfavourable weather conditions, war-induced logistical bottlenecks and trade restrictions in some countries.”

The economists expect that core inflation will be contained by weaker domestic demand, limiting the rate at which firms can pass cost increases onto consumers.

“Despite the expected upturn in inflation, we believe it will remain relatively subdued and below the upper end of the Sarb’s target, hovering at around 5% over the final months of this year, averaging 5.9% in 2023.”

They expect that inflation will be sticky next year, just above 5% in the first six months, before stabilising close to 4.5% over the year’s second half.

“On balance, the risk to the forecast still resides on the upside, due to a vulnerable rand, the upcoming El Niño weather pattern and persistent load shedding, which could still cause food and fuel prices to settle higher than anticipated.”

With inflation expected to remain within the target range and monetary policy already very restrictive, the Nedbank economists expect that the Sarb will probably leave interest rates unchanged.

“Given the uncertainties around load shedding, domestic weather patterns, global oil prices and the rand, the MPC is unlikely to ease interest rates this year. The risk of further US interest rate hikes and its likely adverse implications for the rand will also keep the MPC in a hawkish state of mind. We expect a mild easing to start in 2024.”