Economics weekly
By: Mamello Matikinca-Ngwenya, Siphamandla Mkhwanazi, Thanda Sithole, Koketso Mano
Inflation expected to remain low for now, but a lower target should embed this dynamic over time
So far this quarter inflation has remained below the 3% lower bound of the target. At 2.8% in May, headline inflation continued to reflect the benefit of base effects, contained demand, as well as weak exchange rate passthrough and cost-push pressures. The June figures will be published on Wednesday, 23 July, and should reflect inflation remaining around the 3% mark, with fuel deflation and underlying inflation of 3%. However, food inflation will likely pull headline inflation higher.
Nevertheless, we still foresee inflation contained over the forecast horizon, supported by softer oil prices. In addition, even as demand gradually improves, the output gap remains closed and restricts the passthrough of costs. That said, the fading of base effects and rising utility costs should push headline inflation closer to the current target of 4.5% over the next year. The trajectory of inflation beyond the near term has been affected by the South African Reserve Bank's (SARB's) more aggressive push towards a lower target. We think this shift will happen as soon as possible, with the SARB trying to take advantage of currently benign headline inflation. The May Monetary Policy Committee (MPC) meeting statement included a scenario where inflation is contained at 3%, with no implications for the cutting cycle. In fact, the SARB sees a deeper cutting cycle than currently projected, to below 6% versus 7% with the 4.5% target, as real rates rise and neutral rates fall. While we believe that the SARB's credibility and communication strategy can guide inflation expectations lower, we know that the process takes time - usually around two years. Also, keeping supply-side inflation low is subject to weather patterns and cyclical food inflation, as well as public finance management manoeuvres that will require further traction on structural reforms before government-driven inflation behaves.
Therefore, we still anticipate inflationary pressures that will make it difficult to sustain the current rate of inflation and believe that the SARB will have to work towards a 3% target as a medium-term objective. In line with this, the policy rate should be more conservative than suggested in the SARB's scenario analysis, and while we still anticipate another cut to 7%, nominal interest rates will be more restrictive as the neutral interest rate sheds at least 1.5-percentage points (ppts) alongside the inflation target. Restrictive policy will force further core disinflation, which will be the precursor of all other inflation categories drifting towards 3% given the support from dampened cost passthrough, exchange rate depreciation, and wage expectations. As inflation slows to 3%, policy space would swell, and nominal interest rates would be lowered. Furthermore, policy should gradually shift to a more neutral stance, the risk premium should be lower, South Africa should be less susceptible to shocks and funding cost impediments, and structural drivers such as investment should be more supported.
Week in review
Mining production (not seasonally adjusted) improved in May. Output increased by 0.2% y/y following a 7.7% decline in April. Seasonally adjusted mining output rose by 3.7% m/m, up from 0% (previously 0.6%) in the previous month. This suggests a continued improvement in output in 2Q25, with production up 2.6% in the three months until May. Should this trend continue, mining production will contribute positively to GDP growth.
Retail sales rose by 4.2% y/y in May, after posting 5.2% (previously 5.1%) in April. On a monthly basis, retail volumes recorded 0.1% following 1.1% (previously 0.9%) growth in April. Retail activity over the past three months has reflected no growth compared to the preceding three-month period, suggesting that household spending is losing momentum. That said, any build up in momentum in June will be supportive to GDP growth.
Week ahead
On Tuesday, the leading business cycle indicator for May will be released. The leading indicator recorded a setback in April, declining by 0.3% m/m to 112.8 points, following a 0.8% increase in March. On an annual basis, the indicator was flat (0.0%), moderating from a 2.1% increase in March. The decline was driven by negative movements in seven of the ten constituent variables, which outweighed the positive contributions from the remaining three. The largest drag came from a deceleration in the trend growth rate of real M1 money supply, as well as a decrease in the volume of domestic manufacturing orders. On the positive side, the continued increase in new passenger car sales made the strongest contribution, with its trend growth rate accelerating. An increase in the number of residential building plans approved also made a notable contribution to the leading indicator.
Tables
