What does higher than expected inflation increase mean for repo rate?

Economists are divided about the implications of the higher than expected inflation rate increase to 5.9% holds for the repo rate.

The governor of the Reserve Bank will announce the decision of the Monetary Policy Committee on the repo rate for the next two months tomorrow afternoon.

The South African Reserve Bank (Sarb) has the constitutional mandate to protect the value of the Rand by keeping inflation low and steady. It uses interest rates to influence the level of inflation. National Treasury sets the inflation target in consultation with the Sarb to act as a benchmark to measure price stability.

The Monetary Policy Committee (MPC) of the Sarb independently makes monetary policy to achieve this target currently between 3 and 6%. Monetary policy is implemented by setting a short-term policy rate called the repo rate, that affects the borrowing costs of the financial sector which in turn affects the broader economy.

While Prof Bonke Dumisa, an independent economic analyst, expects the MPC to increase the repo rate by 25 basis points to 8.5% due to inflation increasing more than expected, Prof Jannie Rossouw, visiting professor at the Wits Business School, anticipates the MPC will leave the repo rate unchanged, but with a split vote.

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Oxford Economics Africa says repo rate may increase

Jee-A van der Linde, senior economist at Oxford Economics Africa, says the increase in inflation was higher than expected, raising the likelihood of an interest rate increase, as it is now closer to the upper-end of the Sarb’s target band of 3%-6%.

“The outcome was higher than both our expectations and the consensus forecast of 5.5%.”

He points out that goods inflation rose notably to 8.1%, while annual services inflation eased to 3.8% most recently.

“The divergence can be explained by high input costs for goods due to load shedding and logistic bottlenecks and muted demand keeping services inflation low.”

The South African economy is operating highly inefficiently at the moment and domestic industries are losing competitiveness, while at the same time, the weaker rand contributed to increased exchange rate passthrough to inflation, which represents an upside risk to the outlook for core inflation, he says.

“The Consumer Price Index (CPI) increased by 0.9% in October compared to September, which is more than the 0.5% we pencilled in. Although the increase in fuel price inflation was in line with our expectations, the rise in food price inflation was more than anticipated and core price inflation eased less than we thought.”

The Consumer Price Index measures inflation by tracking the changes in prices consumers paid for a basket of goods and services over time.

“The acceleration in goods inflation is largely driven by supply side factors, while lower services inflation points to soft demand. The South African rand reversed all the gains from its post-budget relief rally and exchange rate volatility is set to continue in the build-up to next year’s general elections,” Van der Linde says.

“The reprieve from fuel price cuts in November and more than likely in December, will not be enough to offset rising prices elsewhere and improve the overall near-term inflation outlook,” he warns.

“South Africa’s inflation rate will probably average 6.0% in 2023 (compared to our initial forecast of 5.8%) and is forecast at 5.4% in 2024. In addition, the current level of inflation, including its recent upward direction, will bother the Sarb. Governor Lesetja Kganyago repeatedly said that the MPC stands ready to act if necessary and we now believe it might during the final meeting of 2023.”

ALSO READ: Reserve Bank expected to keep repo rate unchanged on Thursday

Nedbank says no change to repo rate due to inflation

Johannes Khosa, economist at the Nedbank Group Economic Unit, says since monetary policy is aimed at the future, October’s inflation should not affect tomorrow’s MPC decision.

“We still believe the Sarb has done enough to contain inflation and ensure a sustainable return to the 4.5% target.

“This is evident in weaker domestic demand, slower household credit growth and rising debt defaults. Although we acknowledge the various upside risks to the inflation outlook, we maintain that diminishing consumer demand will offset these risks. Therefore, we expect the Sarb to leave interest rates unchanged tomorrow and start a mild easing in 2024.”

Khosa says the bank expects inflation to moderate in the last two months of the year, mainly pulled down by lower transport costs on the back of softer global oil prices and a steadier rand. “Global oil prices receded in recent weeks as concerns that the conflict in Israel could spread to oil producers in the Middle East and potentially disrupt oil supply chains eased.”

He says the group forecasts that inflation will end the year at around 5%.

“We revised the average forecast for 2023 slightly up to 6% from 5.8% due to October’s higher-than-expected outcome. We also expect inflation to hover around the 5.5% level for most of the first half of next year before falling more convincingly towards the midpoint of the Sarb’s target range during the second half and averaging 5% in 2024.”

However, he says, the risks to the group’s forecasts reside marginally to the upside due to the uncertainties surrounding the outlook for oil prices, food prices and the rand.

“Core inflation will be contained by weaker domestic demand, limiting the rate at which firms can pass cost increases onto consumers.”