Bottom Line: South Africa’s inflation rate fell to 4.7% in July from 5.4% in June, marking the lowest figure in the last two years, driven partly by a favorable base effect, and lower food and fuel prices. This figure is important as the inflation continues to dwindle towards the 4.5% midpoint of South African Reserve Bank’s (SARB) target range (Note: SARB targets inflation 6% in 2023, 5% in 2024 and 4.5% in 2025). The real policy rate has now exceeded the SARB preference for a 2.4% real rate. Combined with the lagged effects of tightening still feeding through, this argues for the SARB not hiking at the September 21 meeting.However, we believe headline inflation may go back to an upward trend starting from August, considering power cuts worsened, food prices globally hiked, transportation bottleneck remained, rand weakening continued in addition to the base effects as July 2022. This will keep a hawkish bias from SARB communications.
Figure 1: Inflation and Core Inflation (%), August 2022 – July 2023
Source: Datastream
Despite the fall in headline inflation accelerated in June and July as inflation for food and non-alcoholic beverages (NAB) slowed for the fourth successive month in July, and fuel prices and transportation costs partly eased, we think the inflation outlook seems cloudy in the upcoming months. In line with our thinking, SARB Governor Kganyago stated on August 25 that there are still risks to inflation and the job is not completed yet, despite inflation has eased to a two-year low in July.Kganyago mentioned that he sees weakening currency as the major risk against inflation outlook as it does have implications for the inflation prospects. (Note: The Rand weakened by 10.7% against USD in 2023 so far and it’s importance extends beyond direct import prices to inflation expectations).
Though South African load shedding issue partly easing in May and June, the situation got worse late July/early August as winter conditions became harsher due to numerous factors such as breakdowns of coal-fired power plants, unit repairs, cold weather, and theft of electricity transmission infrastructure. The country started to experience a full week of load shedding late July, finishing a nine-week long break as it got back to Stage 4 level of load shedding (here). We think growing loadshedding problem signals domestic energy prices would possibly rise later in the winter. Additionally, global oil prices have also picked up since the spring.
One promising development for the economy, though, has been the deals signed between the country and China covering emissions technology, electricity transmission and distribution, and nuclear power during the recent BRICS summit, which may help the government to eventually relieve the country from record power cuts. Electricity minister Ramokgopa underscored that one of the deals would see Chinese companies share technology to help South Africa’s struggling state utility Eskom cut emissions from its coal-fired power plants.
Elevated global food prices following the termination of Black Sea grain deal on July 17 and ongoing war in Ukraine also darken the inflation trajectory in the near term. We believe the country survived the hardship of soaring fuel and food prices as of June and July, but headache may come back most probably in August.
Annual core inflation, which stayed 5.2%-5.3% range between February and May, first decreased to 5.0% in June and 4.7% in July, reaching a 10-month low. This put downward pressure on the consumer prices outlook, after headline inflation had peaked with 7.1% in March in 2023. Despite this, upward pressure to the inflation outlook remain strong, stemming from weakening rand, price of electricity and administered prices such as Eskom tariffs and this could feed into core inflation. (Note: City of Cape Town's recent 17.6% electricity tariff increase along with other municipalities could put further pressure on inflation trajectory.)
Additionally, the SARB inflation expectation survey has stayed high at 6.5% in 2023, since possible increases in domestic fuel prices and stickier prices going forward could ignite inflation in Q4 2023. Hugo Pienaar, chief economist at the Bureau for Economic Research (BER), said on August 30 that “With outsized South African fuel price hikes on the cards in September, headline and core CPI are set to diverge again in coming months.”
Analysts expect inflation to rise to around 5.0% in August due to mentioned factors. Similarly, we expect Q3 2023 inflation to record 5.0%, after steep fall in the rate in the last two months. We predict inflation to pick-up slightly in Q4 ignited by the global oil and food prices hiking and rand losing value (Figure 2) before a slow decline in 2024.
In this respect, despite headline inflation seems cooled off, we think inflation will possibly pick-up starting from August due to negative impacts of the stiffened electricity crisis (loadshedding), base effects as of July 2022, rand weakening, ongoing logistical bottlenecks, and concerns about prospective fuel and food costs.
Figure 2: CE Headline CPI Forecast
Source: Continuum Economics
It is worth noting that the average headline inflation remains within the SARB’s target band, and we believe this inflation figure leaves room for SARB to hold rates steady at 8.25% at the MPC meeting on September 21 despite the Rand continues to weaken and inflation is expected to pick back up. (Note: SARB raised its main interest rate to 8.25 percent - a 14-year high - in May 2023). It is important to note that following July’s inflation recorded 4.7%, the real policy rate has exceeded the SARB preference for a 2.4% real rate. Combined with the lagged effects of tightening still feeding through, this argues for the SARB not hiking in September (here).
