Good news about inflation and interest rates

Inflation remains above the South African Reserve Bank’s (SARB) ideal target, but some overlooked indicators show signs of subsiding, which is good news for interest rates.

This was revealed in FNB’s latest Economics Weekly, written by four of the company’s top economists, which said headline producer and consumer inflation tend to receive the most attention as indicators of inflationary pressures in the economy. 

FNB said this is understandable, given that changes in measures like the Consumer Price Index (CPI) are the SARB’s focus in fulfilling its inflation-targeting mandate. 

However, indications of inflationary pressures across the economy vary and looking at other indicators can provide a broader view of price pressures in South Africa.

Headline consumer inflation recorded an average of 3.3% in 2020, the lowest since 2004 before post-lockdown supply-demand imbalances and geopolitical tensions drove inflation to 6.9% in 2022. 

Following a peak of 7.8% in July 2022, base effects supported inflation as low as 4.7% in July 2023, but it has since stabilised above 5%, settling at 5.2% in April and May of this year.

While lower than when the SARB first began cutting rates, this is still not close enough to the midpoint of the target range – 3% to 6% – that the Reserve Bank is chasing.

The economists said the impact of restrictive monetary policy has been key, limiting the lift in underlying pressures, which peaked at 5.3% in April 2023. 

Another development that supported core inflation’s slowdown was that average core goods inflation was faster than services inflation. 

Core goods inflation reflected global developments more immediately, while firms delayed the passthrough to services.

Simply put, passthrough refers to the process by which price increases at one level in the supply chain are reflected at the next level.

“Had these measures lifted in tandem, headline inflation would have been more pronounced and interest rates more cumbersome,” they explained.

Generally, a weaker passthrough during the 2022 price shock was also evident in Producer Price Index (PPI) dynamics, where price pressures on goods were not fully reflected in consumer goods. 

In 2022, producer inflation peaked at 18.0% in July, with a proxy for consumer-related PPI peaking at 16.9%. Each was at least five percentage points above the peak in CPI goods inflation.

On average, producer inflation was 14.3%, with consumer-related PPI averaging 12.9%, whereas CPI goods inflation was 9.8%. 

“While our analysis reflects a one-way causality from producer inflation, with the passthrough occurring within one to three months, the extent was limited,” the economists said. 

“This implies that retailers experienced margin pressures, given weak consumer fundamentals as a cost-of-living crisis began amid depleting lockdown-related involuntary savings.”

Since April 2023, producer inflation has been running marginally below consumer goods inflation as retailers attempt to gradually claw back some of the losses observed in 2022. 

The latest producer inflation print for May was 4.6% year-on-year, reflecting a moderation from 5.1% in April.

Excluding petroleum-related goods, producer inflation was 3.9%, down from 4.5% over the same period. 

Meanwhile, consumer-related PPI was 4.3%, and CPI goods recorded 5.7%.

The Unit Value Indices (UVI) are another proxy of price pressures, providing indications of how imported unit values are changing. “These should filter through to producer and consumer costs,” the economists explained. 

They said indexing the unit values to the end of 2019 shows how imported cost pressures lifted markedly across consumer-related products in 2022, led by crude and refined products, food products, and recently joined by clothing and footwear. 

Although the UVIs for these items remained elevated in April, lower petroleum product prices and a less depreciated rand should support an easing going forward.

The Q2 2024 Business Confidence Index survey results also suggest rising selling prices, albeit at a slowing pace in the latest reading. 

The inflation expectations survey results for the first quarter of 2024 also showed that average expectations were tame compared to the previous survey. 

Over the medium term, inflation was anticipated to average 5.3% versus 5.6% previously.

Importantly, salary growth expectations (5.0%) were lower than inflation expectations – highlighting that passthrough pressures were weak. 

“Overall, this data points to inflation being faster than the central bank prefers,” the economists said. 

“However, pressures are subsiding, and a less depreciated rand, as well as easing structural constraints such as load-shedding, should be supportive of slower inflation.” 

“We currently project inflation to slow towards 4.5% before year-end and more sustainably over the medium term.”