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[TOP STORY] Base effects and inflation

While further interest rate hikes are expected in 2022, inflation is likely to drop next year and then rate-cuts may be on the cards: Stanlib chief economist Kevin Lings.

SIMON BROWN: I’m chatting with Kevin Lings, Stanlib’s chief economist. Kevin, I appreciate the time today. [We’re] talking base effects and inflation, and delving into [those] a bit. First question, what are these ‘base effects’ and how are they going to impact and have been impacting local and global inflation over the next year?

KEVIN LINGS: Hi, Simon. Yes, the base effects are going to have an enormous impact on inflation. Let me just quickly explain where this is going to come through – and it’s mostly related to the fuel price. Let’s get simple about it. Let’s say the oil price is $100/barrel, and then in 12 months’ time it’s still $100/barrel, the percentage change from one year to the next is exactly 0%. Even though the oil price is actually fairly high at $100, the rate of increase is zero. Now, when you look at oil in South Africa’s inflation, it’s incredibly high; the fuel price at the moment – that inflation rate is sitting at about 50%. And when you look internationally, it’s the same thing. I was looking at US gasoline prices: year on year their number is 50%.

But if the oil price stays exactly where it is and therefore gasoline and the petrol price more or less stays where it is, you’re going to have this enormous rollover of fuel inflation – not just in South Africa, but I guess around the world – and immediately we can see we’ve got a petrol-price reduction that should come through next month and that could set us up for a very nice fall in [the] key category of inflation. And so you can go from 50% [inflation rate] year on year for your fuel price, down to zero quite quickly. And that will obviously help to bring the overall rate of inflation down very substantially during the course of next year.

SIMON BROWN: Yes. So certainly I would imagine by the middle of next year into the second half that would then suggest that in fact inflation should be coming down quite swiftly and back into sort of more under control, I suppose is the phrase.

KEVIN LINGS: Yes. We’ve got an inflation forecast for the end of next year at about 4.6%, which is very close to the midpoint of the inflation target. So yes, inflation at the moment is sitting at over 7% and it’s going to remain high. It’s going to remain over 7% over the next few months.

But let’s say that by the end of next year inflation is more like 4.6%, then what is the Reserve Bank going to be thinking around interest rates? They’re going to be thinking, well, we’ve done our job, inflation’s coming down. We can now start to discuss cutting interest rates as we get closer to the end of next year.

SIMON BROWN: The flip to that question is why then be raising now if there’s a very high likelihood that that base effect will just sort of automatically take inflation down during the course of 2023.

KEVIN LINGS: Yes. That’s critical, Simon, because obviously this base effect is powerful. But the risk in the meantime is that other areas of inflation start to pick up and they take over, so that you find that, yes, the rate of increase in oil and the rate of increase in petrol inflation are moderating, but perhaps wages are going up and clothing inflation and entertainment inflation, and a whole range of other categories are now taking over because inflation has been allowed to take hold.

So what central banks, including the Reserve Bank, [are] trying to do is push up interest rates so that those what we call ‘second-round effects’, those knock-on effects don’t start to manifest and therefore take on a life of [their] own. Yes, you are left with a high petrol price in the short term and there’s nothing the Reserve Bank can do about petrol inflation, but it will slow naturally due to this base effect. So you then have the benefit that next year inflation comes down.

It’s all about ensuring that inflation doesn’t broaden out into many more categories and therefore become a lot more problematic.

SIMON BROWN: Yes. I’ll take your point on that. Therefore, all things being equal, and assuming that what the central banks the world over with rising rates have been doing this year is working, they should, I imagine, start talking rate decreases perhaps by as soon as the middle of next year – or is that overly optimistic?

KEVIN LINGS: No, I don’t think it’s over-optimistic. You can see that central banks are so-called ‘front loading’ the interest-rate hikes. They’re trying to get them up to do the job as quickly as possible. We saw that recently from the Federal Reserve. We’ve seen that from the South African Reserve Bank.

I don’t think they’ll necessarily keep going at that 75 basis-point hike, but you’re going to see further hikes during the remainder of this year.

And then early next year I think you’re going to be at an interest rate [where] most central banks are comfortable that that is high enough in order to do the job they need interest rates to do.

If that starts to then work – the base-effect inflation’s coming down, the interest rate is working on dampening down the spread of inflation – then you’re right, by the middle of next year the discussion is going to be when do central banks start to cut rates, because by then inflation should have moderated substantially. Of course, that’s going to depend on how central banks want to ensure that inflation is firmly inside the target, and they don’t want to give up on their inflation-fighting credentials. So they’ll probably be quite conservative. They’re going to want to make doubly sure they’ve got it under control.

But from a financial-market perspective, that will be the interesting component, because there’s no doubt financial markets are really going to enjoy [the situation] once we see inflation roll over, and once we realise this is the worst it is going to get in terms of interest rates.

SIMON BROWN: Yes. And of course markets are forward-looking so they they’re going to start reacting to that long before it starts to happen.

We’ll leave it there. Kevin Lings, Stanlib’s chief economist, I appreciate the time.

The show is brought to you by Stanlib. Visit to get in touch with one of their investment specialists. Stanlib Asset Management is an authorised financial services provider.

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