The Reserve Bank has maintained the repo — at which it lends to commercial banks — steady at 8.25% for five consecutive meetings, since hiking it by 50 basis points in May 2023.
Inflation shot past 6% in May, marking the first breach of the upper limit of the South African Reserve Bank’s target range in more than five years.
The unexpected leap in annual inflation, which may be the first in a series of nasty economic data readings, will weigh heavily on the bank’s interest rate deliberations next month — and likely cements another steep 50 basis point hike.
Data released by Statistics South Africa on Wednesday showed that the consumer price index (CPI) hit 6.5% year-on-year in May. The print bucked consensus expectations, which forecast a more muted 6.1% jump after inflation held at 5.9% in the two months prior.
The Reserve Bank aims to keep inflation anchored between 3% and 6%, which — until now — it has managed to do in the face of mounting price pressures.
Other countries have not been so lucky: In the most recent example of runaway prices, this week’s data revealed that inflation in the UK climbed to a 40-year high of 9.1% in May. The Bank of England is expecting UK inflation to peak at slightly over 10% by the end of 2022.
The Reserve Bank’s efforts to contain inflation have proven more difficult in recent months, as Russia’s assault on Ukraine continues to bear down on food and energy supplies. Inflation has floated at or above the bank’s 4.5% midpoint target for 14 consecutive months.
Containing pressures
In its last statement, delivered in May, the Reserve Bank’s monetary policy committee (MPC) predicted that inflation would breach the upper limit in the second quarter of this year. Inflation is only expected to return closer to the midpoint in the fourth quarter of 2024.
In May, domestic inflation was driven by food prices. Oil and grain prices soared month-on-month, up 10.1% and 3.4% respectively, signalling the pass-through of higher production costs. Producer price inflation, which measures the change in prices being absorbed at the factory gate, has risen to a record high, reaching 13% in April.
South Africa has felt the effects of Moscow’s war most acutely through higher fuel prices. Crude futures rose to more than $100 per barrel when Russia, one of the world’s largest oil producers, invaded Ukraine earlier this year.
Oil prices have since remained elevated at more than $110 per barrel, as sanctions against Russian oil have tightened, but tumbled 6% on Wednesday amid US recession fears.
In South Africa, which is a net importer of oil, the price of petrol and diesel has risen to prohibitive levels as a result. In June, the price of petrol went up by R2.43 a litre. The steep increase came despite the government having extended the reduction of the fuel levy. The price of unleaded 93-grade petrol has increased by more than 41% in a year.
Petrol prices are expected to increase again in July, prompting forecasters to expect inflation to jump to more than 7%.
Compared to other economies where consumer prices have recently hit record highs, South Africa’s inflation shock is not broad-based. Core CPI, which excludes food and fuel prices, came in at 4.1% in May, which was in line with consensus expectations.
Unlike in advanced economies, like the US, where inflation hit 8.6% in May, South Africa’s inflation has not been driven by the double-whammy of higher demand and constrained supply.
Fragile consumers
South Africa’s economic recovery from the Covid-19-induced slump has not been quite as vigorous, leaving consumers more reluctant to open their wallets. Wages have not yet fully recovered to pre-pandemic levels and consumer confidence, according to an index compiled by FNB and the Bureau for Economic Research (BER), has remained in negative territory since 2020.
However, there is a risk that price pressures could become more broad-based, especially as long-term inflation expectations become unanchored. In the first quarter of 2022, average five-year inflation expectations edged up from 4.7% to 5%. Long-term expectations have a bearing on wage demands, which stand to drive up inflation.
Moreover, a looming taxi fare hike will likely push up transport cost inflation, which contributed a 0.1 percentage point to the overall 0.7% month-on-month rise in consumer prices in May.
Hugo Pienaar, the chief economist at the BER, said that — though there are still a number of unknowns — the next couple of months are likely to produce “fairly ugly readings on the CPI”.
“I still don’t think we will end up having the same sort of dramatic price pressures that we have seen in other countries. But it’s pretty clear now that inflation is going to end up higher than many of us thought,” he said.
The shock 6.5% inflation print will factor into the MPC’s decision next month, Pienaar said, but it alone is unlikely to motivate the committee to up the ante beyond another 50 basis point hike.
Inflation takes 25 basis points ‘off the table’
Last month, the committee decided to raise the repo rate by 50 basis points, the largest increment since 2016. Four of the five committee members voted for the 50 basis point hike, while one member preferred 25 basis points.
The committee is set to meet in a month and will have to decide whether to take a more aggressive approach to curbing inflation, especially as central banks in advanced economies have turned increasingly hawkish. Last week, the US Federal Reserve unexpectedly lifted its rate by 75 basis points, marking the steepest hike since 1994.
Pienaar said: “I don’t think that this number on its own will make them [the MPC] go by 75. But, what it probably does is that it cements another 50 basis point hike. It raises the risk that the Reserve Bank continues with 50 basis points for one or two meetings, as opposed to having the once-off 50 and reverting back to the 25.”
Carmen Nel, the chief economist at Matrix Fund Managers, agreed. Nel expects that inflation will reach 7% from the June inflation print and will remain elevated above that level at least until October.
“I think for July, the question was whether it is going to be 25, is it going to be 50, or is it going to be 75? I think what today’s data does is that it certainly takes 25 basis points off the table,” Nel said.
“I think it firms up a 50 basis point hike … I would argue that, for South Africa’s overall inflation dynamics — given the relatively fragile position of our consumers — 50 is quite aggressive. And I think 75 is very aggressive.”
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