Global Insight, Momentum Investments, blue = below inflation target band, grey = within inflation target band, red = above inflation target band. Source: Stats SA,

Headline consumer price inflation (CPI) inched higher to 5.4% year-on-year (y/y) in May 2017, from 5.3% in April, in line with Momentum Investments’ expectation and the Bloomberg consensus. May is typically one of the lowest survey months, with only 3% of the basket being surveyed in addition to the usual monthly surveys. Relative to Momentum Investments’ forecasts, the largest upside inflation surprises in the individual categories arose in food, tobacco and restaurant prices. The most notable downside inflation surprises were found in the hotels and personal care (including cosmetic items) categories.

The breakdown of the CPI basket suggests that inflation in more than 60% of the items (on a weighted basis) is comfortably below the upper end of the 3% to 6% inflation target range, which is broadly in line with the average recorded post the global financial crisis, but nearly 10% higher compared to the past twelve-month average.


 

Monthly rise in food prices

Food inflation rose 0.6% in month-on-month (m/m) terms in May 2017. The monthly increase in food prices can be attributed to an increase in the price of meat (1.3% m/m) and milk products (1.2% m/m), while prices fell further for fruit (negative 4.1% m/m) and bread/cereals (negative 0.5% m/m).

Meat prices are now 12.3% higher than they were a year ago and have become a meaningful contributor to overall food inflation. The rise in meat inflation has largely been expected as beef prices were set to increase in line with herd rebuilding, while an outbreak of avian influenza in Europe and brining regulations (to reduce the amount of salt water that may be injected into chicken) kept chicken prices high, domestically.

Favourable weather conditions (more than double the normal rainfall in January and February 2017) enabled farmers to significantly increase the area planted for summer agricultural crops, resulting in maize expectations which are nearly 100% higher than 2016 output levels (amounting to around 15 million tonnes in total). While concerns of an impending El Nino weather pattern (often associated with periods of warmer and drier conditions in South Africa) had been raised earlier in the year, the Australian Government Bureau of Meteorology suggests that models are now pointing to neutral conditions for the second half of the year.

 

Power utility Eskom pushing for a 19.9% increase in electricity tariffs for financial year 2018/19

Earlier in the month, Eskom submitted a proposed electricity tariff increase, of 19.9% for 2018/19, for comment to National Treasury and local government association Salga. This follows an increase of 2.2% (1.9% for the municipalities) in the current financial year and 9.3% in the previous year. The final decision on the 2018/19 tariff, which still lies with the energy regulator Nersa, will take place after a round of public consultations. Although a 19.9% electricity price increase is unlikely given the considerable pressure the consumer is under at present, a higher-than-expected tariff poses a key upside risk to the inflation profile in 2018.

 

Underlying measures of inflation stabilise in May 2017

Core inflation (headline excluding food, beverages, petrol and energy) remained steady at 4.8% y/y in May 2017 from a month earlier. This rate is notably lower than the 5.5% average for the past twelve-month period. Disinflation in core goods has largely been responsible for the downward trend in overall core inflation, while core services inflation has persisted at higher levels.

  

Although core inflation is expected to remain below 5% in upcoming months, the lower rate of currency pass-through observed recently suggests that inflation may not experience the full benefit of previous rand strength. Momentum Investments expects core inflation to average around 5.0% in 2017, declining to 4.6% in 2018.

 

South African Reserve Bank (SARB) to exercise caution in the near term

The SARB has warned in its April 2017 Financial Stability Review, that financial stability risks continue to pose a threat to the domestic financial system. Globally, it noted that a faster-than-expected pace of interest rate increases by the United States Federal Reserve and/or a lower commodity price environment (led weaker by reduced Chinese demand) pose a threat to the local currency. Moreover, the SARB Monetary Policy Committee noted in its May 2017 Monetary Policy Statement that the rand remains “highly sensitive to unfolding domestic political uncertainty, as well as decisions by credit ratings agencies”.

Inflation expectations (as calibrated by the Bureau of Economic Research in its Inflation Expectations Survey of labour, business and analysts) have drifted lower in recent quarters, but the level hovers close to the upper end of the inflation target band and remains uncomfortably high. Should the rand weaken considerably in light of above-mentioned reasons, we could see inflation expectations picking up again.

Even though Momentum Investments projects inflation to reach close to 5.5% on average in 2017 (and declining to around 5.0% in 2018), the above arguments likely limits the scope for interest rate cuts in 2017. Nevertheless, SA’s real interest rate profile (nominal interest rates less inflation) stacks up favourably on an emerging market comparison, particularly when using the average one-year ahead expected inflation profile. As such, Momentum Investments is of the view that a favourable real interest rate outlook provides a limited opportunity to cut interest rates by 50 basis points, cumulatively, in the first half of 2018. However, should the rand depreciate more materially relative to Momentum Investments’ forecasts, in response to the above-mentioned global and local risk factors, on a sustained basis such that it impacts inflation expectations negatively, the scope to cut interest rates from current levels would be significantly reduced.  


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