Weak core inflation is likely to keep the headline rate in South Africa close to the bottom of the Reserve Bank’s 3-6% target range both this year and next. This should allow the central bank to keep interest rates low for longer than markets currently anticipate.
- Weak core inflation is likely to keep the headline rate in South Africa close to the bottom of the Reserve Bank’s 3-6% target range both this year and next. This should allow the central bank to keep interest rates low for longer than markets currently anticipate.
- The latest inflation reading of 3.0% y/y in April (down from 4.1% y/y in March) should be interpreted with a degree of caution. Lockdown measures meant that Stats SA could only measure the prices of essential goods and services (mainly food products). (For more, see our Data Response.) We think that the CPI data for May, due next week, will show that the headline rate fell to just 2.4% y/y (mainly due to petrol inflation).
- The figure for May (and for June – which will probably be similar) should mark the trough for inflation. Crucially, petrol inflation, which may subtract as much as 1%-pt off the headline rate in May and June, will start to rise (see Chart 1), and could add 0.5-1.0%-pts to the headline rate through much of 2021.
- Food inflation may rise a bit too, particularly if moves in the rand value of global agricultural prices are anything to go by. (See Chart 2.) That said, we’re not convinced that food inflation will rise as sharply as the chart implies. The relationship between domestic and global food prices is not very strong. And if South Africa’s Crop Estimates Committee is right in projecting a strong harvest, that will also temper food inflation.
- Moreover, the upwards pressure from fuel and food inflation will be offset by weaker core inflation, which tends to follow shifts in the economic cycle (with a lag of about nine months). As a simple way of illustrating this, Chart 3 shows that when the current account deficit narrows (as happens during a downturn, implying that there may be an output gap), core inflation has fallen. The shift to a current account surplus in Q1, and the collapse in demand since then (see here), points to much softer core inflation.
- We doubt that the weakness of the rand will push up inflation significantly. The pass-through from the currency to inflation in South Africa has tended to be small. And in any case, we expect that the rand will strengthen over the rest of the year (our year-end forecast is 16.0/$, versus 17.0$ at the time of writing).
- All told, we expect that inflation will drift up to about 3% later this year and stay there through much of 2021 (barring a brief spike in Q2 2021 caused by petrol inflation). (See Chart 4.) The consensus view is that inflation will rise above 4% next year. Weak inflation should allow the SARB to cut the repo rate further in the coming months (from 3.75% to 3.00%) at this level through the rest of 2020 and 2021. (See here.) Markets are pricing in that the repo rate will fall to 3.25% this year before drifting up next year.
Chart 1: Oil Prices & SA Petrol Prices (% y/y)
Chart 2: FAO Food Price Index & SA Food Prices (% y/y)
Chart 3: Current Account Balance & SA Core Prices
Chart 4: Consumer Prices & Repo Rate
Sources: Refinitiv, FAO, Capital Economics
William Jackson, Chief Emerging Markets Economist, firstname.lastname@example.org