What is the state of the local consumer? The answer matters not only because we are all consumers, but also because consumption spending accounts for 60% of economic activity (when measured by expenditure). Without decent growth in household spending, the economy will be stuck in low gear.
Good news and bad news
Inflation remains surprisingly low. Even with the increase in VAT in April and a series of hikes in the fuel price, the Consumer Price Index (CPI) was only 4.6% higher for the 12 months to June. Core inflation, which excludes volatile food and fuel prices, was only 4.2%, down from 4.4% in May.
The biggest component of core inflation is rent and owners’ equivalent rent (the implied rent that homeowners owe themselves). Actual rents rose only 4.2%, while implied rents were only 3.7% higher, indicating the weak state of the residential property market outside the Western Cape. While rental inflation was 7.5% in the Western Cape, no other province had growth higher than 3.6%. In real (after-inflation) terms, there has been no growth in the national house price average over the past decade.
The bad news is that inflation is low because the economy is weak. Companies cannot afford to raise prices and have to absorb increases in input costs. Landlords can’t afford to increase rent much either.
Optimistic outlook evaporates
The optimism prevalent at the start of the year, when the South African Reserve Bank (Sarb) upgraded the growth outlook at successive Monetary Policy Committee (MPC) meetings, has all but evaporated. The Sarb sharply lowered its real growth forecast for this year, from 1.7% to 1.2%. However, it is still expected to rise modestly to 1.9% next year and 2% in 2020.
At last week’s meeting, the MPC unanimously voted to keep the repo rate unchanged at 6.5%. However, the tone of the post-meeting statement was “hawkish”, warning of several risks that could result in higher-than-expected inflation: oil, the rand, interest rates in the United States and Eskom tariff hikes.
On the other hand, actual and forecast inflation is well within the Sarb’s target range of 3% to 6%. Moreover, each of the risk factors has at various points in the recent past moved in the wrong direction from an inflation-targeting point of view, without resulting in runaway inflation. The graph shows the limited response of the CPI to the fairly dramatic rises in the prices of petrol and electricity, as well as the volatile exchange rate.
The sharp decline in the oil price in recent days and the rand steadying at about R13.50 to the dollar indicate that another big petrol price increase next month is unlikely.
The MPC still views its policy stance as “accommodative”, but if rates were really accommodative, we’d see much faster credit growth.
The rate of borrowing is slowly creeping up for households, but it has declined rapidly for companies. Consumers have benefited somewhat from the 0.5% reduction in the repo rate over the past year, but further reductions are highly unlikely. Given the Sarb’s hawkish stance, modest interest-rate increases in the coming year cannot be ruled out. If they materialise, they will be driven by external factors rather than domestic developments.
Wage growth slowing
On the income side, we don’t have any new official data. But we have news that Post Office trade unions settled for a 6.5% wage increase and Eskom workers seem to be settling on 7.5%.
The MPC noted that it expects wage increases to average 7%, although this number will hide a wide discrepancy among companies and between the private and public sectors.
If the average wage increase is still above inflation, consumers will enjoy real income growth, supporting spending. But the trend is declining. The days of unions forcing double-digit wage increases seem to be over. At least the MPC will welcome this, because it sees inflation-plus wage increases (rather than productivity-linked raises) as a key source of inflation pressure.
Sentiment surprisingly high
Consumer confidence is surprisingly high, according to the FNB/BER Consumer Confidence Index. The index jumped to a record (and unrealistically) high level in the first quarter, following the political changes in the country, but fell back only a few index points in the second quarter.
On the outlook for the economy, consumers are still very positive, and similarly for the outlook for household finances. On whether the present time was suitable to buy durable goods (such as cars and furniture), the respondents were neutral. StatisticsSA released numbers on the motor trade showing virtually no growth in the sales of new and used vehicles to May.
Sales growth slide
After-inflation retail sales grew by 1.9% year-on-year in May, more than expected. This was better than April’s 0.5% (probably affected by the VAT hike), but still below the 4% to 5% growth rates recorded late last year and into the first months of 2018. Particularly noticeable is the slowdown in nominal growth, which declined from 7% at the start of the year to only 3.8%. This means that the inflation rate at retailers has declined to only 1.7%. Although low inflation is good news for consumers, retailers need price increases to lift revenue growth.
Implications for investors
As citizens, taxpayers and consumers, there is some cause for concern, given the slow pace of growth. It helps that the global economy is strong, despite the threats of trade disruptions. And while “New Dawn” optimism might have faded, we must not forget where we were only a year ago.
As investors, the above matters much less. First, even in a standard balanced fund, the exposure to the local economy is less than commonly thought. Second, much of the negativity about the prospects of South African-focused companies has been priced in already. Third, high real interest rates, while probably constraining economic growth, are to our advantage as investors. Finally, low inflation means it is easier to achieve real returns.
Dave Mohr and Izak Odendaal are the chief investment strategist and investment strategist respectively at Old Mutual Multi-Managers.