Bad news for inflation and interest rates in South Africa

Inflation is likely to remain structurally higher over the next decade, as globalisation retreats and trade barriers increase worldwide.

This will translate into higher interest rates, particularly in the United States, which will have ripple effects worldwide. 

As the United States looks to reshore manufacturing and supply chains through the use of tariffs on imports, inflation will be around one percentage point higher on average in the coming decade. 

This is feedback from Old Mutual Investment Group (OMIG) portfolio managers John Orford and Graham Tucker, who published the asset manager’s annual Long-Term Perspectives report. 

The report outlined some of the trends OMIG is currently watching and how they will impact investing in the future. 

It also makes clear which asset classes and investment styles perform the best over time, despite fluctuations in macroeconomics and political events. 

One of the significant trends Orford and Tucker are watching is the steady retreat of globalisation, which began before Donald Trump ascended to the White House for the first time. 

With the rise of a significant challenger to the United States in the form of China, the world is once again multipolar. 

The US appears to have responded to this challenge by decoupling its economy from China’s and by reshoring manufacturing. 

This is being done through various measures, including tariffs, and signals the end of the steady integration of the global economy. 

Globalisation appears to have stalled, with global supply chains fracturing and countries retreating into regional trade. 

This implies that inflation is likely to be higher going forward, as increased production costs will be passed on to consumers. 

As a small and highly open economy, South Africa will not be immune to the effects, even if they are primarily contained in the United States. 

If global inflation rises, so will local inflation, as the country imports a significant portion of its goods and is highly dependent on trade for economic growth. 

The graph below shows the expected higher average global inflation over the past decade in comparison to the past twenty years and the retreat of globalisation. 

Silver lining for South Africa

One major benefit South Africa will have in this environment is its young population, which stands in contrast to the rest of the world. 

Orford explained that alongside the retreat of globalisation, inflation will rise due to the reversal of long-term trends regarding ageing populations. 

Over the past twenty years, the world has benefited from a young population that was highly productive. However, this is shifting as populations age in developed economies and parts of Asia. 

An ageing population poses a serious risk to countries as it increases the number of dependents per employed worker. 

This means that there are effectively fewer producers and more takers in significant economies, increasing the tax burden on younger individuals and raising the cost of production. 

In turn, this will raise prices across the board and result in structurally higher inflation from increased wages offered to workers. 

However, South Africa may avoid the worst effects of this due to its young population by global standards. 

Allan Gray’s chief investment officer, Duncan Artus, believes the country’s demographic dividend is one of its greatest advantages over the coming years. 

A larger proportion of the population being of working age can boost economic growth through increased savings, increased labour force participation, and investment in human capital. 

Artus explained that the tailwind is a common factor among emerging markets that have grown strongly in recent decades, as a growing workforce is central to strong economic growth, with exceptional productivity growth.

“This is my last slide because a lot of the questions are negative on South Africa, but we have one good thing going for us in the country versus the developed world,” Artus said. 

“We have a growing population and, crucially, we have a growing young population that is able to work and grow the economy.”

However, Artus warned that this tailwind is at risk of being wasted in an economy that has not experienced meaningful growth over the past decade. 

“We have a lot of young people and we have a lot of young people in the workforce, but we do not have an expanding labour force participation rate,” Artus said. 

“As our chairman, Ian Liddle, says, ‘It does not help if you have got a lot of young people that do not have a job’.”