Inflation rate of 7.4% means consumers must prepare for repo rate headache

The high inflation rate of 7.4% for June spells nothing good for the repo rate, which is expected to be announced tomorrow.

Consumers are already struggling with high food and fuel prices and expectations of a 75 basis point increase in the repo rate will definitely not put their minds at rest.

According to research group Oxford Economics Africa, after the surprise increase in inflation in May and the latest rise in price inflation, the South African Reserve Bank (Sarb) is forecast to hike the repo rate by 50 bps during its upcoming July policy meeting, with more frontloading to follow, which should see the repo rate end the year at 5.75%.

Also Read: Possible 1% repo rate increase coming to punish your wallet

“It is likely to be a tight call with expectations for a 75 basis points hike. Meanwhile, record high fuel prices will increasingly stifle economic activity in the second half of the year, while the spill-over effects will see price inflation remaining sticky at elevated levels.”

Oxford Economics Africa forecasts that inflation will average 6.5% in 2022.

“Government’s temporary fuel relief will be fully withdrawn at the start of August, which implies that, all else being equal, fuel prices will start August R0.75 per litre higher.

“That said, while international oil prices have eased somewhat on a monthly basis in July, the Rand has depreciated to multi-year lows, dimming prospects of a fuel price reprieve next month. Our revised currency forecast sees the Rand ending the year at R16.78/$, averaging R15.95/$ for 2022 as a whole.”

ALSO READ: Inflation for June surges by 1.1% to become highest in 13 years

Inflation rate not encouraging for investors

David Rees, senior emerging markets economist at Schroders, says while investors are looking for signs that high rates of inflation are moderating, the first tranche of new monthly numbers for June is not encouraging.

“Inflation in South Africa is seen across the board. Higher commodity prices have fed through to increases in food and energy inflation, but core inflation has also been rising steadily.”

Have we finally reached the peak in food and energy inflation? Rees says from the commodities perspective, there are diverging risks in South Africa when it comes to the outlook for food and energy inflation.

“For example, projections based on futures prices indicate that items, such as petrol inflation, should start to come off quite sharply in the second half of the year. The obvious risk is that oil prices take another leg up. However, there appear to still be upside risks to food inflation, which has been creeping higher over the past couple of years.”

He says the relationship between food prices and local food inflation is not as strong as it was in the past, but there is a clear risk that food inflation will rise further. Rees points out that rising core inflation has been a global phenomenon and reopening frictions and disruption to global supply chains have boosted goods prices.

“However, where there are concerns about wage-price spirals in some economies around the world, this should not be an issue given structurally high unemployment in South Africa. Tighter policy and spare capacity ought eventually to also weigh on core inflation.”

Rees warns that looking ahead, it seems unlikely that a resolution to the invasion of Ukraine will be found anytime soon and this means that geopolitical risks emanating from Russia will continue to cast a shadow over the outlook for commodity prices for some time.

“Energy markets are particularly vulnerable amid concerns that Russia will cut off gas supplies to Europe. Meanwhile, disruption to fertiliser supplies threaten agricultural prices, along with climate change and country-level export bans of some food stuffs.”

ALSO READ: Shocking inflation rate increase for May spells more trouble for consumers

The role of the fuel price

Independent economist Elize Kruger says the hefty increases of R2.38/l for petrol and R1.10/l for diesel in June contributed 0.6 of the 1.1 monthly change in the CPI basket.

“Fuel price inflation rocketed to 45.3% year-on-year and as South Africa is very dependent on road transport, the extent of this increase forces a pass-through of higher transport costs into the generally higher prices of many other items in the economy, the so-called secondary impact on inflation. Most evident in a hefty public transport increase of 4.3% m/m in June, 14.3% y/y, as higher fuel price inflation spills over into higher taxi fares.”

Her advice to spot second round effects in the inflation release:

• if core inflation, which excludes the volatile food, fuel and energy prices, comes out higher than expected it indicates that the broader basket’s prices are collectively moving higher as was demonstrated in June when core inflation was 4.4% compared to the market consensus of 4.3% year-on-year.
• if the residual item’s contribution to the monthly change in headline CPI increased by more than the previous month, it again indicates that prices in the smaller weighting items are moving higher. The residual’s contribution to monthly change was only 0.1% vs 0.2% in the previous two months (Apr & May).
• if there are unexpected (“surprise”) increases in items. In June public transport increased by 4.3% compared to May in June and 14.3% year-on-year, as higher fuel price inflation spills over into higher taxi fares.

Kruger expects that a further round of hefty increases in fuel prices in July (petrol up by 247c/l and diesel up by 231c/l) will result in the July headline CPI number trending even higher to 7.8% year-on-year, which she believes should be the upper turning point of the current headline CPI cycle. 

“Average headline CPI for 2022 is forecast at 6.9%, the highest annual average since 2009 when it was 7.1%. For 2023, headline CPI is forecast to moderate to 5.7%, back into the Sarb’s 3-6% target range, but still a bit too high for comfort.”

She also thinks that the higher inflation rate will render the Monetary Policy Committee (MPC) uncomfortable and as such a further 50 basis points hike in the repo rate is forecast when the MPC concludes its current meeting on Thursday, with a growing risk that the Sarb might follow the boldness displayed by global central banks and hike the repo rate by 75 basis points.