INFLATION figures released on Wednesday showed a sharp acceleration, vindicating the Reserve Bank’s 50 basis-point rate hike last month.
Higher food prices, the effects of a weaker rand and a lower base for petrol prices compared with a year ago pushed up consumer inflation to 6.2% compared with 5.2% in December. It was the highest in 17 months and was within the Bank’s expectations.
Inflation that rises out of the 3%-6% target band suggests more and higher interest rate hikes are looming.
But the dilemma faced by the Bank was emphasised in better-than-expected retail sales data, also released on Wednesday. In December retail sales were up 4.1% compared with a year ago, although the pace of growth is expected to slow significantly this year.
Consumer spending — the main driver of economic growth — will be negatively affected by rising inflation, food prices and interest rates. The slowdown in spending by households will be a drag on the economy.
Therefore the Bank is in a tight spot: rising inflation necessitates higher interest rates although slowing economic growth begs for unchanged rates.
The R1.23/l fall in the petrol price in January last year created a low base effect, without which last month’s inflation figure would have been closer to 5.5%, said Investec chief economist Annabel Bishop.
Last month it was the first time since August 2014 that inflation breached the upper end of the target band and forecasts by economists and the Bank are for it to remain above 6% for a while.
The Bank itself expects inflation to peak at 7.8% in the fourth quarter.
"A sustained breach of the target range or worse-than-expected inflation outcomes would necessitate further interest rate hikes. However, growth is so weak that any further hikes could severely hamper economic activity," Bureau for Economic Research economist Harri Kemp said.
Nedbank economists expect 25 basis-point rate hikes at the March, May and July monetary policy committee meetings.
That view is supported by forward-rate agreements for two months’ time, which climbed five basis points after the inflation data was released on Wednesday, pricing in a 25 basis-point rate increase next month.
Forward-rate agreements are used to speculate on borrowing costs and are a key indicator of what could happen to interest rates.
Drought-induced food price increases, higher electricity tariffs and a weak rand will be the main drivers of inflation in coming months.
And an increase in inflation expectations will encourage the Bank to push up rates.
Shortages caused by the drought mean SA will have to import maize and other staples and that will be costly with the weak rand.
Rating agency Moody’s said on Tuesday the drought was pushing SA to the brink of a recession.
In a separate report on Wednesday, the agency was again scathing about SA, saying marked capital outflows in recent months were a reflection of "a lack of confidence in the government’s ability to deliver growth-enhancing measures in the short term".
The agency also pointed out, in line with forecasts by other economists, that consumers’ resilience would be tested as a deterioration in profitability of the corporate sector spilled over to lower-income growth.
Real incomes would be compressed by rising inflation as a result of the weaker rand.
Consumers would also have to contend with tax increases, widely expected to be announced in the budget next Wednesday.
Although motorists will enjoy a petrol price drop of about 55c/l next month, prices could rise again in April as the government is expected to implement higher levies for fuel.
With rising fiscal pressures, the Treasury could take advantage of low international oil prices and increase the general fuel and Road Accident Fund levies to bolster revenue collections, MMI Investments economist Sanisha Packirisamy said.
For last year at least, consumer spending appears to have been one of the main drivers of the country’s economic growth, as suggested by the 3.3% increase in retail sales for the year compared with 2014.
"We are less optimistic for the year ahead … we anticipate a tightening of lending criteria, little to no job creation, rising inflation and, consequently, interest rate hikes," FNB senior industry economist Jason Muscat said.