SA’s inflation outlook remains challenging
We expect domestic headline inflation to slow in coming months, but also that a range of factors will limit the rate of disinflation, leading to higher inflation than markets expect and the need for restrictive policy settings, for longer.
After some resilience at the start of this year, global inflation has fallen fast off its peak in the third quarter of 2022. The sharp moderation has comforted policymakers, while raising expectations that sticky core inflation will follow suit.
However, concerns remain as to whether core inflation will soon return sustainably to target from currently elevated levels. This reflects the unusual nature of the post-pandemic inflation shock and will keep central banks vigilant and biased to more tightening.
South Africa's inflation has also turned, but has declined more slowly than global peers. Core inflation has been sticky, despite the weak economy. We believe there is a risk that changes in the post-pandemic economy and shifting inflation drivers will slow the pace of domestic inflation's moderation.
Global headline consumer inflation – including volatile food and consumer fuel markers – slowed to 4.3% year on year (y/y) in May, with a monthly gain of just 0.1%. This is broadly in line with pre-pandemic monthly growth, and annual rates are a full three percentage points (ppt) lower than a year ago.
Consumer energy prices have been an important driver of the moderation. The two ppt drop in this component of the inflation basket between April and May was broad-based across countries, with the US seeing fuel prices down -3.6% y/y, Japan -3.7% and the UK -1.6%.
In Europe, household fuel is concentrated in residential energy prices, and here too declines and base effects are building momentum, with more to come into year end.
Global food prices have also started to ease, as sharply lower agricultural commodity prices feed through into food products. Monthly gains have slowed from 0.7% month on month (m/m) to 0.4%, helping annualised inflation slow to 3.8% from 7.6% at the start of the year.
Oil
Looking ahead, inflation is expected to continue slowing, although some of the disinflationary momentum may moderate in the second half of 2023 (H2-23), especially if international oil prices recover, and as base effects fade.
Food inflation is expected to ease further, although risks are building from a recent rise in key commodity prices, a drier planting season (El Niño, notably in Latin America) and the war in Ukraine's threat to the Black Sea grain deal.
Nonetheless, that headline inflation is heading meaningfully lower is positive for real incomes and provides some support for consumption and growth and offers some relief to policymakers.
Core inflation has been much less cooperative. May's core inflation growth slowed to 0.4% m/m, but the annual gain remains close to 5%, and the monthly annualised rate is also close to this level – which is a long way from convincing central banks that their job is done. Within this, services inflation is still running at a 6% annualised rate.
This is where most of the policy-setting focus is, because it is the cleanest inflation indicator of monetary policy transmission (i.e., is policy tightening having the desired effect?). While trends by region vary, indicators linked to wages suggest that in some areas – like the UK – price pressures are still alarmingly high. Core goods inflation, which had moderated sharply with the normalisation of supply bottlenecks is now rising again in the US.
Most forecasters expect core inflation to follow headline CPI lower with a lag, as it did on the way up. Certainly, past rate hikes will take time to offset the tailwinds of previous policy accommodation and bed down price- and wage-setting behaviour.
Slowing wage growth and industry surveys indicating that inflation pass through has peaked suggest this is already underway, and June core inflation data offers a mixed bag of evidence of easing. That said, a sustainable return to target levels is expected only by the end of 2024, or later in developed markets, and this forecast is usually predicated on a combination of additional rate hikes, and an anticipated mild recession in the US.
Global
While that pace may be slower, South Africa's inflation trajectory shares similar features to its global peers, but also has distinct differences. Headline inflation peaked at 7.8% y/y in July 2022 – on average lower than both developed and emerging market peers. Since then, moderating transport costs and a recent peak in food inflation – coupled with a building drag from base effects in these two components – has seen inflation ease to 6.3% y/y in May 2023. In June, CPI slowed to 5.4% y/y, somewhat lower than expected.
Core inflation slowed to 5.0%, supported by weaker core goods inflation, coupled with weak hotel- and domestic-wage pressures. However, after a long period of very weak growth, rental inflation has picked up.
While we expect headline inflation to slow further in coming months, we expect core inflation to accelerate from current levels into 2024, and to remain elevated at about 5% in the longer term. This contrasts to the South African Reserve Bank's (SARB) and market expectations for core prices to moderate roughly in line with headline inflation to the mid-point of the target.
Economic forecasting is fraught with challenges and, in the wake of the pandemic, the forecast errors for inflation for much of the world were significant. In part, this reflected the dramatic changes the pandemic imposed on countries and, in particular, the profound mismatches between demand and supply, the unprecedented and extended stimulus, and the changed shape of economies in its aftermath.
South Africa also emerged from the pandemic with an economy that looks different to how it did before. Unemployment is considerably higher; employment has almost recovered, but only just and to weak levels overall.
Real gross domestic product (GDP) is hovering at about pre-pandemic levels (give or take), but some sectors have not recovered, in part because network industries, which are really like the vascular system of the economy, are on life support. Government debt is much higher, and the fiscal position more vulnerable, which has raised risk premia and discouraged capital flows contributing to a weaker currency.-Fin24
After some resilience at the start of this year, global inflation has fallen fast off its peak in the third quarter of 2022. The sharp moderation has comforted policymakers, while raising expectations that sticky core inflation will follow suit.
However, concerns remain as to whether core inflation will soon return sustainably to target from currently elevated levels. This reflects the unusual nature of the post-pandemic inflation shock and will keep central banks vigilant and biased to more tightening.
South Africa's inflation has also turned, but has declined more slowly than global peers. Core inflation has been sticky, despite the weak economy. We believe there is a risk that changes in the post-pandemic economy and shifting inflation drivers will slow the pace of domestic inflation's moderation.
Global headline consumer inflation – including volatile food and consumer fuel markers – slowed to 4.3% year on year (y/y) in May, with a monthly gain of just 0.1%. This is broadly in line with pre-pandemic monthly growth, and annual rates are a full three percentage points (ppt) lower than a year ago.
Consumer energy prices have been an important driver of the moderation. The two ppt drop in this component of the inflation basket between April and May was broad-based across countries, with the US seeing fuel prices down -3.6% y/y, Japan -3.7% and the UK -1.6%.
In Europe, household fuel is concentrated in residential energy prices, and here too declines and base effects are building momentum, with more to come into year end.
Global food prices have also started to ease, as sharply lower agricultural commodity prices feed through into food products. Monthly gains have slowed from 0.7% month on month (m/m) to 0.4%, helping annualised inflation slow to 3.8% from 7.6% at the start of the year.
Oil
Looking ahead, inflation is expected to continue slowing, although some of the disinflationary momentum may moderate in the second half of 2023 (H2-23), especially if international oil prices recover, and as base effects fade.
Food inflation is expected to ease further, although risks are building from a recent rise in key commodity prices, a drier planting season (El Niño, notably in Latin America) and the war in Ukraine's threat to the Black Sea grain deal.
Nonetheless, that headline inflation is heading meaningfully lower is positive for real incomes and provides some support for consumption and growth and offers some relief to policymakers.
Core inflation has been much less cooperative. May's core inflation growth slowed to 0.4% m/m, but the annual gain remains close to 5%, and the monthly annualised rate is also close to this level – which is a long way from convincing central banks that their job is done. Within this, services inflation is still running at a 6% annualised rate.
This is where most of the policy-setting focus is, because it is the cleanest inflation indicator of monetary policy transmission (i.e., is policy tightening having the desired effect?). While trends by region vary, indicators linked to wages suggest that in some areas – like the UK – price pressures are still alarmingly high. Core goods inflation, which had moderated sharply with the normalisation of supply bottlenecks is now rising again in the US.
Most forecasters expect core inflation to follow headline CPI lower with a lag, as it did on the way up. Certainly, past rate hikes will take time to offset the tailwinds of previous policy accommodation and bed down price- and wage-setting behaviour.
Slowing wage growth and industry surveys indicating that inflation pass through has peaked suggest this is already underway, and June core inflation data offers a mixed bag of evidence of easing. That said, a sustainable return to target levels is expected only by the end of 2024, or later in developed markets, and this forecast is usually predicated on a combination of additional rate hikes, and an anticipated mild recession in the US.
Global
While that pace may be slower, South Africa's inflation trajectory shares similar features to its global peers, but also has distinct differences. Headline inflation peaked at 7.8% y/y in July 2022 – on average lower than both developed and emerging market peers. Since then, moderating transport costs and a recent peak in food inflation – coupled with a building drag from base effects in these two components – has seen inflation ease to 6.3% y/y in May 2023. In June, CPI slowed to 5.4% y/y, somewhat lower than expected.
Core inflation slowed to 5.0%, supported by weaker core goods inflation, coupled with weak hotel- and domestic-wage pressures. However, after a long period of very weak growth, rental inflation has picked up.
While we expect headline inflation to slow further in coming months, we expect core inflation to accelerate from current levels into 2024, and to remain elevated at about 5% in the longer term. This contrasts to the South African Reserve Bank's (SARB) and market expectations for core prices to moderate roughly in line with headline inflation to the mid-point of the target.
Economic forecasting is fraught with challenges and, in the wake of the pandemic, the forecast errors for inflation for much of the world were significant. In part, this reflected the dramatic changes the pandemic imposed on countries and, in particular, the profound mismatches between demand and supply, the unprecedented and extended stimulus, and the changed shape of economies in its aftermath.
South Africa also emerged from the pandemic with an economy that looks different to how it did before. Unemployment is considerably higher; employment has almost recovered, but only just and to weak levels overall.
Real gross domestic product (GDP) is hovering at about pre-pandemic levels (give or take), but some sectors have not recovered, in part because network industries, which are really like the vascular system of the economy, are on life support. Government debt is much higher, and the fiscal position more vulnerable, which has raised risk premia and discouraged capital flows contributing to a weaker currency.-Fin24
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