Inflation (CPI) slightly up – new Outlook for the Interest Rate

South Africa’s Consumer Price Index (CPI) – the main index for measuring inflation – surprised to the upside in August, increasing by 6.4% year-on-year (y/y). This follows a 6.3% y/y print in July, and is the first inflation pickup in three months.

h3. Product Basket

CPI was pushed higher by a rise in food (+9.5% y/y), alcoholic beverages and tobacco (+6.1% y/y), vehicles (+6.4% y/y) and well as clothing and footwear (+5.3% y/y) inflation. Meanwhile, petrol inflation slowed significantly to 5.8% y/y (from 8.3% in July) as a result of base effects and an unchanged petrol price in August. The main upward pressure on food inflation came from a 1% month-on-month (m/m) rise in meat prices. It appears as if farmers are currently restocking herds, while feed costs are relatively low. This is creating some short term pressure on supply. Meanwhile, new tariffs on chicken imports may also be pushing up meat prices. The rise in clothing and vehicle inflation likely reflects a lagged impact of the previous depreciation of the Rand. This impact is expected to fade unless the Rand experiences a sustained period of depreciation over the coming months (which is not our view). Core CPI increased slightly to a new four-and-a-half year high of 5.8% y/y in August.

h3. Outlook Inflation

Looking ahead we expect inflation to fall to 6% y/y in September as a result of a large petrol price cut and slightly lower food inflation. Beyond that, falling grains prices and a period of relatively stability in the exchange rate should see inflation drop – and remain – below 6% in 2015.

h3. Outlook Interest Rate

The higher inflation have increased the risk of an interest rate hike by the SA Reserve Bank (SARB) today. We think the print justifies our call of a high risk of a rate hike”, he said but added it is not enough to tip the MPC over the edge. The latest CPI news reminded Montalto that, while the underlying trends are painfully slow, they are still progressing. We still see minimal demand-side effects though some feed-through of higher retail wage inflation and higher energy costs at the change of municipal contracts in the second quarter is evident, non-core surprised us to the upside, generated mostly by food price disinflation still not kicking off, despite such sharp falls in raw food commodities, suggesting bouncy profit margins which the SARB has been fearful of.

h3. Impact of Rand Performance

Gina Schoeman, Citi’s economist for South Africa said given the extent of rand weakness over the years Citi has been saying for some time that it is reasonable to expect core inflation to rise to the 6.0% target ceiling in the forth quarter of 2014. “However, evidence from the listed retail sector is that pass-through will remain limited and, in our opinion, tolerable by the Sarb given the extent of GDP downgrades this year,” said Schoeman. She said the near-term outlook for food inflation is tricky to predict given that the typical 9-month lag between rising maize prices in the first quarter of 2014 and retail store prices was not fully passed through by producers, in Citi’s view.

“We caution that the next CPI September print has a strong seasonal lift in monthly food prices, which could stall a more certain downward trajectory. For petrol, the 67c/litre petrol price cut in September should help keep the next CPI print on a downward trajectory. However, for October we caution that recent rand volatility may result in a petrol price hike by October,” said Schoeman. She sees the September rates unchanged despite the upside CPI surprise on Wednesday.

“We continue to see more than enough rationale for an unchanged rates stance at tomorrow’s MPC decision: Not only is the CPI trajectory expected to slow from here on – and only to remain out of target for another two quarters – but GDP downgrades have been significant this year and, by already hiking twice since January, the SARB has bought credibility that its core mandate remains price stability,” said Schoeman. “We thus affirm our view that, despite the data-dependent nature of MPC meetings and the rand volatility that is likely to oscillate as the markets head closer to actual Fed hiking, the economy is now so weak that the SARB will need to keep as much ‘firing power’ as it can for the second quarter of 2015 when we see US monetary policy tightening.”

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