FIFI PETERS: Today Statistics South Africa confirmed the news that we’ve all known for some time – and that is that the cost of living is rising. It is probably rising too high for most people’s comfort because it’s really becoming a lot more difficult to make ends meet. So consumer inflation, as we have been talking about throughout the entire day on this station, came in at 6.5% in May. It was the usual suspects that drove prices higher – food, fuel and electricity. We know the story by now.
But let’s [look deeper] and have a more in-depth discussion on CPI and exactly what this means, and why we should really care. Old Mutual chief economist Johann Els joins us for more. Johann, thanks so much for your time. Good to speak with you again. Most economists, I understand, had expected CPI to come in at 6.1% in May. It has come in higher than that. How far was today’s reading – the 6.5% – from your own expectations?
JOHANN ELS: Thanks, Fifi. I had 6.2%. It jumped from 5.9% and above my 6.2% to 6.5%. That was a bit of a reality kick, certainly because there were some extra price increases apart from the usual ones that you mentioned in your intro – appliances, non-alcoholic and alcoholic beverages, personal-care items. So a wider range of stuff has been going up, and that is worrying indeed.
FIFI PETERS: Worrying because inflation is becoming a lot more broad-based beyond the food and the fuel and the electricity? It’s practically now hitting everything. Worried because of that and what this could mean?
JOHANN ELS: Yes, exactly. But then we have to take into account as well that personal consumption expenditure growth was particularly strong in the fourth quarter of last year and in the first quarter of this year, as we’ve seen in Stats SA’s GDP numbers. So perhaps there was some opportunity for retailers to pass on more of their lagged costs over the past few years into consumer pockets because they’re realising that, hang on, consumers can actually afford to pay these increased prices.
I am worried about that, but that is also one of the factors that I think won’t necessarily last because, as you also said, we’ve all got limited budgets. Now we spend more on the essentials and we are surely going to spend less on those more luxury-type items, so there are going to be some downward pressures.
In effect, these higher petrol and food prices are doing some of the job of the Reserve Bank already by adjusting spending patterns, by being deflationary in some of the other components.
So yes, you are right, I am concerned, but I am thinking that maybe there are some deflation effects at play within the basket of products here.
FIFI PETERS: Like what?
JOHANN ELS: The fact that we are spending less on non-essentials, on luxury goods, so there’ll be some price adjustments there. Unfortunately, we won’t immediately see that because we’ve got a system where CPI is measured on a fixed-weight basis. You and I now spend less on perhaps whisky or luxury cars or whatever, so, in effect, the price increases there will be slower, but that doesn’t follow through into the headline because the weights won’t change immediately. In the US, they’ve got PCE deflator [personal consumption expenditure deflator], where the weights are adjusted every month. We haven’t got that extra system of looking at inflation.
In effect there is some deflationary effect coming through, but of course the problem here is that the headline number is going up. That is what you and I see. We start to build that into our price expectations and that is what the Reserve Bank is mostly concerned about.
FIFI PETERS: Talking about whisky, you are right, prices there are rising at a slower pace than everything else – 5.6% in the month of May. If you’re a wine drinker, hard luck, prices up 7.9%. Beer drinkers too, hard luck, prices up 7.8%.
Jokes aside, Johann, yesterday we heard from the South African Reserve Bank governor talking at some conference – I’m not too sure which one, I think it was the SA Tomorrow Investor Conference.
JOHANN ELS: You are right, yes.
FIFI PETERS: He was talking about his concerns around imports, its inflation, and just looking at what is happening in the inflation baskets elsewhere in the world. The UK today also came out with its numbers at 9.1%, the highest in 40 years. It’s a similar story [to what] we have seen in the US, and we know that the Eurozone inflation basket is also pretty high, north of 8%. How worried are you about inflation or imported inflation hitting us?
JOHANN ELS: Of course I am concerned because of those high inflation numbers in those countries. But, because the rand has been relatively stable even though we’ve seen a little bit of weakness, it’s not the typical pattern – where when the US Fed becomes very aggressive the rand actually tanks – because of improved local fundamentals, like we’ve got a decent current account surplus, the fiscal position has been improving, the growth environment has been improving, so the rand has been more stable than usual, and that helps negate some of the negative impact from higher imported prices. But of course the Fed and the more hawkish offshore central banks are doing some of the job there.
Surely those inflation numbers are close to peak territory in my mind, and will start rolling over. I think we are perhaps at the worst possible time regarding that, and things will gradually improve from here onwards in terms of imported price inflation.
FIFI PETERS: I was talking to Annabel Bishop of Investec earlier today. She was giving her projections of peak inflation as she saw it. She put it at 7.3% – and we’re likely to get it at the next CPI print. What’s your forecast of where inflation will peak and when it’s likely to start coming down?
JOHANN ELS: I think we’ve roughly all got the same type of assumptions. I’ve got 7.2% in June as a peak – I mean [when] it starts coming down. But then the exact level of the peak and when the peak happens will heavily depend on the oil price. The war in the Ukraine is a big determinant of food and fuel prices and that will determine when the peak is.
But certainly I believe that inflation will start easing off. I’ve got 6% by the end of this year and below 5% by the end of next year.
The one [bit of] magic behind it, of course – economists shouldn’t use the word ‘magic’, but inflation is a year-on-year calculation – [is that] even if price levels remain high if you compare them on a year-on-year percentage change basis, you start seeing some improvements. So that helps.
Of course the fact that we are all pressured by cost increases and spend less on some other goods will also start to help. Interest rate increases will start to make an impact. Inflation is over the next couple of months probably close to a peak.
FIFI PETERS: I assume that, like your other colleagues in the economics fraternity right now, you are expecting our Reserve Bank to be pretty spooked by the inflation print that came out today, and want to act and act quickly on it. So your expectations of what the central bank may do, the local one, to interest rates next time around?
JOHANN ELS: As I said earlier, it is probably most worried about the impact on inflation expectations, because that could be potentially the biggest risk or the driver behind future inflation. So it wants to nip that in the bud.
So I think in July at their next meeting that it will almost certainly hike by another 50 basis points to sort of front-load this fight against inflation.
[The members] know they can’t do anything about the first-round pricing impact, so the second round or the inflation expectation is what they want to limit. So 50 basis points.
But I also think that today’s print has likely raised some probability that they will consider a 75 basis point increase. I do not think they will do that, so that’s not my base case, but I think there will be some talk around that. That’s not because the Fed did that because, as I said earlier, [with] improved local fundamentals we don’t need to follow the Fed to that extent. But because they want to fight inflation expectations they might consider 75 basis points.
My base case is 50 basis points. I do think that the front loading, the May 15, July 15, means the cycle will probably end sooner or there might be a pause over the next couple of meetings – that they don’t hike every single meeting.
I still think overall the circumstances are such to see that. This is a moderate normalisation cycle in terms of interest rates. By that I mean probably another 125 basis points, maybe 150 basis points in total in terms of hikes in this cycle. That will only take us back to what we had in February 2020, in other words before the emergency Covid cuts started. So we are only going back to that type of level.
FIFI PETERS: Investec has the probability of a 75 basis point increase at the July meeting at 30%. So what’s your probability, if you say that the print has raised the chances that that could be on the table?
JOHANN ELS: Mine is probably around 20%. So significantly below 50%. So not a base case.
FIFI PETERS: We’ll have to wait and see what happens in the lead up to July. Johann, thanks so such for your time, sir. We’ll leave it there. Johann Els is chief economist at Old Mutual.