Various risks keeping inflation from decreasing

Various risks are expected to keep inflation from decreasing economists say after inflation increased to 5.6% in February from 5.3% in January. These risks are the weak economy, fuel prices, weather influence on food production and the volatile rand.

Core inflation, which excludes food and fuel prices, increased further to 5% from 4.6%, but the economists at the Nedbank Group Economic Unit, Isaac Matshego and Nicky Weimar, still expect it to ease in the second half of this year due to the weak underlying economic momentum.

“We expect inflation to resume its downward trend in the coming months, although the decline will be slower than we had previously anticipated. Risks to the inflation outlook remain slightly tilted to the upside.”

Matshego and Weimar say higher fuel prices will add to inflation in the next few months. Petrol prices increased by another 5.2% in March compared to February and by 6.5% compared to a year ago, while gains in global oil prices have offset the slight appreciation of the exchange rate, pointing to more fuel price increases in April.

“Drier weather conditions due to the El Niño weather pattern in the southern hemisphere could reverse the recent moderation in food inflation,” they warn.

ALSO READ: Inflation up again in February

Volatile rand remains a risk

The rand’s volatile exchange rate remains a key risk, with the local unit likely to remain jittery due to election-related uncertainties, they say.

“Moderate global demand growth and subdued domestic demand will maintain downside price pressures. We now expect inflation to average 4.5% in the final quarter of 2024 and 5.1% (previously 5%) for the year.”

They still expect the Monetary Policy Committee (MPC) of the South African Reserve Bank (Sarb) to start its cutting cycle in July and reduce interest rates by 25 basis points at each of the three meetings in the second half of the year. Therefore, the prime rate will end 2024 at 11% from 11.75%, with two more cuts in the first half of 2025 taking it to 10.5%.

Jee-A van der Linde, senior economist at Oxford Economics Africa, says although the February inflation print was in line with their expectation of 5.6%, prospects of a weak currency, higher international oil prices and El Niño pose upside risks to South Africa’s inflation outlook.

“We retain our above-consensus average inflation forecast of 5.2% for 2024 and still expect rate cuts to start coming through gradually only in the third quarter.”

ALSO READ: Inflation increases again in January

Inflation closer to the upper end of the Sarb’s target band

He points out that headline inflation accelerated to 5.6%, moving closer to the upper end of the Sarb’s target band of 3%-6%.

“The outcome was in line with our expectations but slightly higher than the consensus forecast of 5.5%.”

Van der Linde says for now, their average inflation forecast of 5.2% for 2024 remains intact, but risks to the inflation outlook remain firmly tilted to the upside.

“More specifically, the rand is likely to remain skittish, international oil prices have increased since the start of the year, while the adverse effects of El Niño have only recently become noticeable.”

Adequate soil moisture conditions made for favourable summer crop planting conditions at the end of last year, but insufficient and erratic rainfall, together with a heatwave during January and February, meant that the picture has changed as El Niño conditions bite.

The Crop Estimates Committee’s (CEC) first production forecast for South Africa’s 2024 summer grain crops indicates combined production of mainly maize (14.4 million tonnes), soybeans (2.1 million tonnes) and sunflower seeds (671 100 tonnes) declining 13.5% this season to roughly 17.4 million tonnes from the 20.1 million tonnes yielded in 2023.

“Although we expect food inflation to oscillate around 6% over the coming months as the lag between agricultural and retail food prices should delay the feed-through to price inflation, the risk of increased price pressure towards the second half of 2024 is of some concern.”

Van der Linde says the February inflation print feeds into their above consensus forecast for inflation to average 5.2% in 2024.

“It also reinforces our view of what we think will happen to interest rates going forward, which is for a gradual and possibly shallow cutting cycle.

ALSO READ: Inflation down but not expected to change repo rate

Sarb will start cutting rates in September – economist

“We forecast that the Sarb will implement the first 25 basis points cut in September, followed by another one in November. With South African monetary policy still deemed restrictive, authorities are mindful of the increasing economic hardship consumers face but also alive to the heightened risk of capital outflows.”

At the same time, the Sarb has been quite tolerable of low economic growth, he says.

“Expeditious policy tightening by the US Federal Reserve has also seen the real interest rate differential between South Africa and the US narrow.

“South Africa’s elevated risk premium limits the extent to which the Rand benefits from the positive interest rate differentials with advanced economies. The Sarb therefore does not have the luxury to implement early rate cuts.”

In addition, he says, much will depend on the future actions of major advanced economy central banks and domestic monetary policy will remain tight. He also points out that the Sarb noted again in January that it still sees serious upside risks to inflation.

“Consequently, the Sarb will want clear evidence that inflation is sustainably reverting to the midpoint of the target band (3%-6%) before it considers lowering interest rates.”