By: Mamello Matikinca-Ngwenya, Siphamandla Mkhwanazi, Thanda Sithole, Koketso Mano
A lower inflation target for SA
Last week we discussed South Africa's (SA) delayed cutting cycle relative to other emerging markets (EMs), particularly Latin American EMs. We indicated that not only did most of these countries start hiking rates earlier than SA but that, even with the cuts that have been delivered, real interest rates remain restrictive. We concluded that higher real interest rates in those countries make them more competitive for capital flows and touched on the levers that SA could use to improve its attractiveness. One is to reduce the risk associated with SA assets, i.e., improved productivity and potential growth, the other being a reduction of the inflation target. Both would contribute to better exchange rate dynamics, more stable inflation1, and ultimately, lower neutral interest rates which embed structurally lower nominal borrowing costs.
It is important to note that lowering the inflation target was part of the plan when SA adopted the inflation targeting regime in 2000.2 The target was meant to glide from 3-6% to 3-5% by 2004, then to 2-4%. However, this was delayed by the rand depreciation shock in 2001. Since then, this objective has only translated into a midpoint target of 4.5% when the Quarterly Projection Model, which required a point-target, was adopted by the Monetary Policy Committee (MPC).
3The SARB has increasingly made clear its pursuit of an officially lower inflation target, possibly 3%, in line with most EMs. While it is likely that there will be short-term costs to economic activity, there will also be longer-term gains - for borrowers, savers and, importantly, those with less financial buffers to hedge themselves from elevated and volatile inflation. Even when considering the short-term cost of disinflation, the SARB argues that it is lower with a credible and independent inflation targeting regime since moral suasion does most of the work. Relatedly, the SARB makes the point that its communication has improved, and inflation expectations have become more forward-looking. Therefore, an announcement of a lower target would be more seamlessly absorbed by wage and price setters, enforcing lower future inflation. The headache in the current period is that real wages and margins have already been constrained by high inflation over the past two years, and households and businesses may not be willing to delay their claw-back. Furthermore, multi-year wage agreements in government and mining, for example, are detrimental to making speedy adjustments towards a new target.
The other headache is administered pricing behaviour, e.g., water and electricity. Price adjustments in these key network industries tend to lack indexation to headline inflation and moral suasion has not yet yielded meaningful results. Excluding tertiary education and data cost inflation, we haven't really seen structural adjustments in the admin basket. We still await the revision on how fuel prices are determined and, Eskom, as well as municipalities, tends to seek price inflation that caters for financial rebalancing - especially in the context of elevated inequality. Without robust gains from liberalisation, an artificial reduction of admin inflation should still fall on the taxpayer, through the fiscus, and lift the risk premium.
Whether the sacrifice ratio is as small as hoped or not, SA finds itself in stiff competition for external savings in an era of less cheap money and heightened risk. We may not afford to simply fare better than less credible policy destinations such as Turkey, but rather look toward being compared with high-performance countries like India. This is only one key avenue, and the SARB will likely push for it to be another contribution to structural reform. We think it will affect their policy stance and we allow our expectations for future meetings to reflect this. We discuss these expectations next week.
1 Even during times of positive GDP shocks. Ndou, E. & Gumata, N., 2024. Should the South African Reserve Bank lower the inflation target band? Insights from the GDP-inflation nexus. Journal of Policy Modeling.
2 Kganyago, G. L., 2021. Inflation targeting at 21- lessons for the future. Stellenbosch, South African Reserve Bank.
3 Loewald, C., Makrelov, K. & Pirozhkova, E., 2022. The short-term costs of reducing trend inflation in South Africa, Pretoria: South African Reserve Bank Working Paper Series.
Week in review
Mining production, not seasonally adjusted, declined sharpy by 5.8% y/y in March, after expanding by 10.3% y/y in February, in part, due to unfavourable base effects, the mid-March and Easter holidays as well as water shortages. The outturn was worse than the Reuters consensus prediction of a more moderate 1.8% y/y decline. Seasonally adjusted mining output, which aligns with the official calculation of quarterly GDP growth, fell sharply by 5.0% m/m, compared to a 5.3% m/m increase in the prior month. Overall, output declined by 1.7% q/q in 1Q24, after expanding by 2.4% q/q in 4Q23, confirming that the mining sector's gross valued added (GVA) dragged GDP growth.
The Quarterly Labour Force Survey (QLFS) data, a household-based employment survey not seasonally adjusted, revealed a resurgence in employment momentum in the first quarter of this year. Employment increased by 21 555 q/q (or 0.1%), rebounding from a decline of 21 587 in 4Q23. However, the unemployment level surged by 330 454 q/q (4.2%) to reach 8,225,889, reflecting a significant influx of new entrants into the labour market. Consequently, the official unemployment rate rose to 32.9% from 32.1%. The level of employment was up by 552 471 (3.4% y/y) compared to the same quarter last year, indicating that the post-pandemic recovery remains entrenched above the 4Q19 level despite domestic economic challenges.
Retail sales expanded by 2.3% in March, from a decline of 0.7% in February, likely boosted by holiday-related consumer shopping activity. The outcome was ahead of market expectations, with Reuters consensus predicting a mild expansion of 0.4%. On a month-on-month basis, volumes increased by 1.4%, up from 1.0% in February, and -3.3% in January. Nevertheless, this data means that volumes declined by 0.9% q/q in 1Q24, implying that the retail industry dragged quarterly GDP growth. Retail volumes continue to reflect a subdued consumer demand environment, weighed on by sticky inflation, high interest rates and depressed consumer confidence. In addition, the prevailing tight lending standards, in the face of elevated debt service costs and default rates, should keep credit growth relatively contained, further limiting consumers' ability to fund purchases. That said, there are some faint glimmers of hope in the medium to long term, emanating from a continued slowdown in inflation and modest job gains.
Week ahead
On Tuesday, the leading business cycle indicator for March will be released. In February, the leading indicator surged by 1.7% m/m from -0.2% in January and arresting the previous two consecutive months of decline. This reflected a lift in five constituent variables, which outweighed decreases in the other half. On a year-on-year basis, the leading indicator fell by 0.9%, from -2.9% previously. The improvement in the leading indicator is encouraging but this annual data still marked twenty-three consecutive months of decline and an overall weak economic climate is likely to persist.
On Wednesday, data on consumer inflation for April will be released. Headline inflation slowed to 5.3% in March from 5.6% in February, with monthly pressure of 0.8%. Driving the monthly pressure was core inflation. Core inflation lifted by 0.7% m/m and 4.9% y/y, primarily driven by education, housing, as well as alcoholic beverages and tobacco. Fuel increased by 5.3% m/m and 6.2% y/y, while food and NAB inflation continued to ease, settling at 5.1% y/y from 6.1% previously. We expect monthly pressure on headline inflation to slow in April as the weight of periodical surveys fall. Nevertheless, fuel inflation should continue to provide upward pressure. Annual headline inflation should remain flat at 5.3% y/y. We anticipate headline inflation to average 5.2% for 2024.
The key data in review
| Date | Country | Release/Event | Period | Act | Prior |
|---|---|---|---|---|---|
| 14 May | SA | Mining production % m/m | Mar | -5.0 | 5.3 |
| SA | Mining production % y/y | Mar | -5.8 | 10.3 | |
| SA | Official unemployment rate % | 1Q | 32.9 | 32.1 | |
| 15 May | SA | Retail sales % m/m | Mar | 1.4 | 1.0 |
| SA | Retail sales % y/y | Mar | 2.3 | -0.7 |
Data to watch out for this week
| Date | Country | Release/Event | Period | Survey | Prior |
|---|---|---|---|---|---|
| 21 May | SA | Leading indicator | Mar | -- | 112.8 |
| 22 May | SA | CPI % m/m | Apr | -- | 0.8 |
| SA | CPI % y/y | Apr | -- | 5.3 |
Financial market indicators
| Indicator | Level | 1W | 1M | 1Y |
|---|---|---|---|---|
| All Share | 79,508.98 | 2.5% | 8.9% | 1.4% |
| USD/ZAR | 18.20 | -1.5% | -4.4% | -5.4% |
| EUR/ZAR | 19.76 | -0.7% | -2.3% | -5.2% |
| GBP/ZAR | 23.05 | -0.3% | -2.6% | -4.2% |
| Platinum US$/oz. | 1,057.17 | 8.1% | 10.5% | -1.1% |
| Gold US$/oz. | 2,376.44 | 1.3% | -0.3% | 19.9% |
| Brent US$/oz. | 83.27 | -0.7% | -7.5% | 8.2% |
| SA 10 year bond yield | 11.23 | -1.4% | -4.3% | -4.2% |
FNB SA Economic Forecast
| Economic Indicator | 2021 | 2022 | 2023f | 2024f | 2025f | 2026f |
|---|---|---|---|---|---|---|
| Real GDP %y/y | 4.7 | 1.9 | 0.6 | 1.2 | 1.5 | 1.6 |
| Household consumption expenditure % y/y | 5.8 | 2.5 | 0.7 | 1.3 | 1.3 | 1.5 |
| Gross fixed capital formation % y/y | 0.6 | 4.8 | 4.2 | 4.0 | 4.2 | 3.6 |
| CPI (average) %y/y | 4.5 | 6.9 | 6.0 | 5.2 | 4.7 | 4.5 |
| CPI (year end) % y/y | 5.9 | 7.2 | 5.1 | 4.9 | 4.7 | 4.6 |
| Repo rate (year end) %p.a. | 3.75 | 7.00 | 8.25 | 8.00 | 7.50 | 7.50 |
| Prime (year end) %p.a. | 7.25 | 10.50 | 11.75 | 11.50 | 11.00 | 11.00 |
| USDZAR (average) | 14.80 | 16.40 | 18.50 | 18.70 | 17.70 | 18.30 |
