Bad news about inflation and interest rates

South Africa is unlikely to be able to sustainably bring inflation down below the midpoint of the Reserve Bank’s inflation target range, as administered price increases and a weakening rand will keep prices rising. 

The Reserve Bank has hiked interest rates by 475 basis points since November 2021 to lower inflation. 

While inflation has come down substantially, it remains towards the upper end of the bank’s 3% to 6% target, forcing it to keep rates at 15-year highs for just over a year. 

This has put tremendous pressure on local consumers, with the effects of rising prices compounded by increased debt-servicing payments. 

Data from Trade Intelligence shows that over a third of all South Africans with debt have missed more than three monthly repayments. 

This indicates that consumers are taking more debt than they can pay off and are increasingly relying on credit to purchase basic necessities. 

While South Africans’ overall debt burden has grown, so has the cost of servicing this debt. The Reserve Bank said debt repayments comprise over 9% of all household expenditure. 

As the bank has raised interest rates to 15-year highs, South Africans with mortgages, car loans, and credit cards have seen their repayments skyrocket. 

Relief is expected to come in September, with economists predicting the Reserve Bank will begin cutting rates at its next meeting. 

However, Stanlib chief economist Kevin Lings urged caution in his latest research note, saying that rates are unlikely to decrease significantly in the next 12 months. 

This is because several forces are driving prices higher, limiting the chances of inflation dipping towards the middle of the Reserve Bank’s target range. 

A major driver of inflation is the rising prices of administered services from the government and, to a much lesser degree, the private sector. 

For example, the cost of electricity averaged a growth of 15.2% year-on-year in the first five months of 2024 and has not been below 6% for many years. 

The cost of water rose by an average of 7.9% in the first five months of 2024, education by 6.1% and medical aid by 10.6%.

These percentage increases keep inflation high as they are nearly universal inputs into economic activity, effectively raising the cost of doing business and, thus, prices. 

Lings said this means that bringing the inflation rate fully under control (4.5% or lower) is heavily reliant on controlling the cost increases of key essential services. 

Unfortunately, the extensive infrastructure backlogs the country is facing, coupled with the public sector’s severe fiscal constraints, suggests that administered prices are likely to escalate for many years.

Large price increases in essential services are not South Africa’s only longer-term inflation concern. Two other factors need to be highlighted. 

First, the rand exchange rate tends to weaken by an annual average of around 5.5%, more than the inflation differential between South Africa and the US. 

This adds to cost pressures in the domestic economy, especially since it has become increasingly more import-intensive in recent decades.

Second, the ongoing strength of South African trade unions tends to keep the overall increase in wages at or above the top end of the inflation target. 

At the same time, the country continues to struggle with declining levels of productivity, which undermine the country’s competitiveness, adding a layer of costs that companies are constantly trying to recoup.

Finally, there is also a technical factor at play in how inflation is measured in South Africa, which has the potential to skew the data. 

It is very noticeable that SA’s inflation success over the past ten years is partly attributable to the fact that the cost of renting a house has been especially low, at an average of only 3.5% over the ten years, Lings said. 

This largely reflects the country’s ongoing weak economic performance. 

Rental inflation is the largest single component of the consumer price index, with a weight of 16.49%. Thus, with it remaining subdued, upward pressure on inflation has been limited to a degree. 

However, a sustained increase in economic activity, coupled with a rise in employment, is likely to push rental costs meaningfully higher, given that the cost of building a house far exceeds the cost of buying an existing house.