Lower inflation welcome but not unexpected

The lower inflation rate was welcome, although it was not unexpected, economists say after inflation decreased to 6.3% in May after its unexpected increase in April to 6.8%. This is the lowest reading since May 2022.

After Statistics SA announced the new inflation rate on Wednesday, Oxford Economics Africa said the decrease supports its view that CPI inflation will return to the South African Reserve Bank’s (Sarb) inflation target band by the end of the first half of the year.

However, the group says food price inflation eased further from peak levels but will remain elevated over the coming months.

The inflation rate for May was again lower than the group’s expectation as well as the consensus forecast of 6.5%. The Consumer Price Index (CPI) increased by 0.2% month-on-month in May compared to the 0.4% increase in April.

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The main contributors to the annual inflation rate were the usual suspects:

• food and non-alcoholic beverages increased by 11.8% and contributed 2.1 percentage points;
• housing and utilities increased by 4% and contributed 1 percentage point;
• transport increased by 7% and contributed 1 percentage point;
• miscellaneous goods and services increased by 6.3% and contributed 0.9 percentage points.

Oxford Economics Africa says although food price inflation has indeed peaked, prices will remain elevated over the coming months.

Core inflation that excludes volatile items such as food, non-alcoholic beverages, fuel and energy, eased slightly to 5.2% compared to May last year, while the latest data also shows that goods inflation dropped to 8.0% compared to May last year, when it was 9.0%, while annual services inflation was unchanged at 4.7%.

Good news for consumers

What does it mean for consumers? Oxford Economics Africa says the favourable inflation outcome for May means that South Africa’s real interest rate is calculated at roughly 2% and is back at pre-pandemic levels.

“Our base case remains for inflation to average 6.1% in 2023, as we anticipate favourable base effects to dissipate from August onwards. The impact of a weak rand exchange rate, relatively high fuel prices and power outages are also keeping costs elevated for businesses in general.”

The group says with previous rate increases yet to fully filter through to the real economy and CPI forecast to return to the Sarb’s inflation target band by the end of the first half of 2023, in conjunction with the weak growth environment, additional interest rate increases could be too restrictive.

“Although further tightening will not boost the rand, our base case is for a further 25 basis points rate increase in the third quarter, pushing the repo rate to 8.5%.”

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Prof Raymond Parsons, economist at the North-West University business school, says it is welcome but not unexpected good news that headline inflation for May continued to show a declining tendency.

“Although food costs remain high, the overall downward trend in headline inflation is converging on earlier consensus expectations of South Africa getting closer to the goal of price stability in the months ahead. Core inflation, however, remains stubborn for now.”

Parsons says the inflation outlook must now also be seen in conjunction with the latest leading business cycle indicator of the Sarb, which declined further in April.

“On an annual basis, this leading business cycle indicator fell by 9.1% year-on-year. Other recent high-frequency economic data also strongly reinforce the expectations of much weaker business conditions prevailing in the second half of 2023, with downside risks.”

Will Sarb pause repo rate like US Fed?

Forecasts for economic growth in 2023, therefore, hover between only 0.1% and 0.3%, he says. “The present crosscurrents in the economy suggest that the Sarb should take a leaf out of the US Federal Reserve’s book and consider pausing further interest rate hikes at its July meeting.

“There are time lags between monetary policy decisions and their effects on the real economy that need to be weighed. It is now necessary for the Sarb to also assess what the cumulative impact of its rate hikes since November 2021 has had on the economy.”

ALSO READ: Although inflation cooled in April, price embers still smouldering

Adriaan Pask, CIO at PSG Wealth, says while local inflation is still above the upper limit of the Sarb’s target range of between 3% to 6%, PSG expects it to start decreasing as the Sarb hiked interest rates to combat high inflation.

“According to the Sarb’s monetary policy review, the country’s inflation levels should reach the target range in the second half of this year and current data supports this.”

Johannes Khosa and Nicky Weimar, economists at the Nedbank Group Economic Unit, say Wednesday’s inflation outcomes are encouraging and suggest that inflation could still decelerate faster than the market’s current expectation.

Inflation dipping into target band

“We now see inflation dipping into the target band in June, ending the year at 4.9% (previously just above 5%) and averaging 5.9% (6.1% previously) over the whole year. The downward pressure will continue from receding global inflation, notably sharply lower international oil and food prices. Weaker domestic demand will also increasingly erode companies’ pricing power, containing the rate at which firms can pass cost increases onto consumers without reducing sales significantly.”

However, Khosa and Weimar warn upward pressure will continue to emanate from the higher domestic production costs and a weaker rand.

“These underlying price pressures are evident in the stickiness of core inflation.

“Given the many uncertainties surrounding the inflation outlook, especially the rand’s murky prospects amid persistent geopolitical risks and the US Federal Reserve’s hints of further rate hikes, the Sarb will likely remain hawkish. We still expect one more rate hike of 25 basis points in July.”