South Africa's price pressures are proving stickier than the Reserve Bank had hoped. Governor Lesetja Kganyago has warned that inflation expectations are drifting away from target, with early signs of so-called second-round effects now showing up across the economy — a development that strengthens the case for further interest-rate increases.
Expectations on the move
When the Bank lifted its repo rate by 25 basis points to 7% in May, its first hike in three years, it did not yet have the latest reading on inflation expectations, Kganyago told CNBC Africa on Friday. That picture has since shifted. “We now have inflation expectations, and expectations have drifted away from target,” he said, adding that price-setters across the board are now budgeting for higher inflation. Reining those expectations back in, he argued, is precisely what the central bank has to act on.
The numbers underline the concern. Core inflation, which strips out volatile food and fuel costs, quickened to 3.8% last month from 3.6%, while headline inflation accelerated to 4.5% from 4%. Kganyago expects core inflation to peak only in the first quarter of next year, and reaffirmed the Bank's commitment to dragging the rate back towards its 3% target.
Oil and the rate path
Much of the uncertainty hangs on oil. The recently signed US-Iran deal has eased some of the pressure that the conflict injected into crude markets, but Kganyago cautioned that prices are unlikely to return to pre-conflict levels any time soon, and many analysts expect them to stay elevated into next year. Higher fuel costs feed quickly into transport and food prices, keeping the inflation thermometer warm.
Markets are already bracing for more tightening. Economists surveyed by Bloomberg over the past week expect the Bank to add another quarter-point at its third-quarter meeting. For households and businesses still absorbing May's hike, the message from the Reserve Bank is clear: it would rather act early than let expectations harden.
