When inflation rates start coming in lower than expected, that can be a good portent, suggesting that something benign is happening that the market is not quite factoring in yet.
Latest data show consumer price inflation came in lower than expected in May, as it did in April. It is still too early to be sure that the trend will be sustained. It is also too early to expect the Reserve Bank to be persuaded that the inflation trajectory is firmly downward, so too soon yet to call an end to the interest rate hiking cycle. But there are at least some good pointers.
Inflation figures are backward looking not forward looking and it is the forecast not the history that the Reserve Bank’s monetary policy committee looks at. The latest headline inflation number, at 6.3%, is the lowest in 13 months, and is within sight of the top of the target range. It is still a long way from the 4.5% midpoint that is the Bank’s effective target. But it is expected to fall to within the range within the next month and to end the year closer to 5%.
Slower increases in food and fuel prices helped in May. And though on an annual basis food price inflation is still well into painful double digits at 12%, it has come off a peak of 14.4% and is slowing on a monthly basis, with a slowdown in agricultural price inflation boding well for future months. Economists now expect inflation this year could average 6%, which is lower than the Bank’s 6.2% forecast at its most recent monetary policy committee meeting even if still at the top of the range.
If inflation outcomes are looking relatively more benign, so too is the rand exchange rate. It blew out to almost R20 to the dollar during May, with potentially dire implications for inflation, but has since retraced its steps, with a strong performance during June. The US Federal Reserve’s decision to keep rates on hold at its meeting last week could also help to take the pressure off the currency, and the Bank.
Several economists argue that SA has reached the end of the interest rate hiking cycle. Others expect at least one more 25 basis point hike. There certainly are reasons for the Bank to keep worrying. It closely watches core inflation, excluding volatile food and fuel prices, as a guide to underlying price pressures in the economy. While core inflation edged down to 5.2% in May, it is still stuck well above the midpoint.
Nor is the rand yet out of the woods. It still is the biggest risk to inflation. Fed chair Jerome Powell was still hawkish when he briefed the US Congress this week, which could mean US rates stay higher for longer, keeping emerging market currencies under pressure.
In the rand’s case, the big risks still stem from SA’s economic woes and foreign policy missteps. Load-shedding and low growth will continue to weigh on the exchange rate, but so too will question marks over SA’s supposedly nonaligned stance and its invitation to Russian president Vladimir Putin.
Monetary policymakers will want to stay cautious despite better inflation news.
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