In August 2011, headline CPI inflation rose by a modest 0.2%m/m, with the annual rate remaining unchanged at 5.3%y/y. This was lower than market expectations, which was for an increase of 5.5%y/y and 0.4%m/m.
For 2010 as a whole, SA CPI inflation averaged a very respectable 4.3%y/y, but is clearly trending higher, despite the side-ways move in August. The better than expected inflation outcome increases the chances of a rate cut this week, but this is still not our base case.
During August 2011 there were only two significant increases in CPI worth highlighting. The first was a 0.3%m/m increase in food prices, which added 0.1 of a percentage point to the monthly change in inflation. On an annual basis, SA food inflation eased to 7.3%y/y from 7.5%y/y in July. While we have been expecting that the upward momentum in domestic food price inflation would moderate, the renewed upward pressure on international agricultural prices in early September, coupled with the recent weakness of the Rand, is a concern worth monitoring.
The second was a 1.7%m/m increase in the petrol price (petrol price rose by 17c/l in August). This also added 0.1 of a percentage point to the monthly increase in CPI. Petrol inflation is currently up at 23.5%y/y. Unfortunately, the petrol price rose by a further 9c/l in September and the current under-recovery on the petrol price is a massive 38c/l (average under-recovery for the month is at 25c/l). This will result in a substantial increase in the petrol price next month.
CPI excluding food and fuel is still well within the inflation target at 4.3%y/y, and recorded a relatively modest monthly rise of 0.1%m/m. Services inflation eased to 5.4%y/y from 5.5%y/y in July.
As we have mentioned over the past few months, it is concerning to see that the inflation rate for lower income earners remains above 6%y/y, while the inflation rate for pensioners is now up at 6.0%y/y.
Looking ahead, there are still some upside risks to SA inflation. These include mainly administered prices, although the latest round of wage agreements could also reflect in a broadening of inflation. The extent to which these price pressures will impact core/underlying inflation will be heavily influenced by the strength of the domestic economy (which is currently slowing, thereby creating less opportunity for companies to pass-on cost pressures) as well as the Rand exchange rate. There is little doubt that the relative strength of the Rand in 2010 cushioned SA from some potentially damaging price pressure, but this could change going into 2012.
All of these factors clearly suggest that there is some further upside risk to inflation in 2011/2012, albeit driven mostly by cost push or external (international) factors. We expect CPI inflation to breach 6% in early 2012 and remain around 6% for most of 2012.
The latest international economic developments (especially the increased risk of a recession in the developed world coupled with the recent decision by the Federal Reserve to keep rates on hold until mid-2013) dictate that the Reserve Bank keep interest rates on hold for a very extended period. The current upward trend in inflation also reduces the chances of a cut in domestic interest rates; unless the SA economy returns to recession conditions, which is not our base case forecast - although we do expect that the domestic economy will reflect slower growth over the coming quarters.
We therefore expect the MPC to keep interest rates on hold this week, but there is a growing risk that the MPC could opt to cut rates in the last meeting of 2011 or the first meeting in 2012, if the SA economy continues to significantly lose momentum.
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