Fuel inflation the biggest risk in Sarb’s repo rate decision

Despite inflation for October being pretty much in-line with expectations and stabilising at 5%, fuel inflation on the back of a sharp increase in crude oil prices and a significantly weaker rand will be the biggest risk factor when the South African Reserve Bank (Sarb) decides on whether to hike or hold its repo rate at 3.5% on Thursday.

Economists and market commentators are split, and the Sarb’s Monetary Policy Committee (MPC) is likely to also have a split vote this time round, after unanimous repo rate votes at the last few meetings.

Read: SA inflation unchanged before key rate decision

The latest repo rate decision, set to be announced by Sarb Governor Lesetja Kganyago just after 3pm on Thursday, is arguably the most anticipated one of the year, considering it being just ahead of the festive season and with ever-increasing prospects for the start of a rate hiking cycle.

Central banks around the world are facing an increasing inflation threat and the Federal Reserve in the US has taken a notably hawkish tone in recent months touting tightening rates next year, which has been one of the factors hurting the rand in recent months.

While SA inflation stabilised in October, the spike in fuel prices to record levels in November needs to be recognised and will be a key risk factor to the inflation outlook taken into consideration at the MPC.

The price of petrol (93 unleaded) alone surged by R1.21 on November 3, taking the inland price to R19.32 a litre. But with the rand weakening further since the end of October, the AA has already warned that the petrol price will hit a new record high of over R20 a litre in December. That’s unless the rand strengthens by the end of this month or oil prices fall materially.

Fuel inflation may not be the biggest component of SA’s inflation basket, but it is also worth noting that if the petrol price tops R20 a litre in December, it will have increased by over R5 a litre since the beginning of this year.

“Headline inflation remained unchanged at 5% in October 2021. Financial markets were steady following the release, given that the figure was broadly in line with the Bloomberg consensus forecast of 5.1%. The price increases in food/non-alcoholic beverages and transport were largely responsible for the monthly increase in the Consumer Price Index (CPI) of 0.2% (month-on-month),” Sanisha Packirisamy, economist at Momentum Investments said in a research note on Wednesday.

Read: SA will move on rates if inflation persists, Kganyago says

“Fuel inflation rose 23.1% year-on-year [y/y], after factoring in a 1c/l dip in 95 petrol [inland in October] but is expected to rise into year-end on a weaker local currency and higher international oil prices, amid a global energy crunch,” she however cautioned.

Nevertheless, Packirisamy expects the Sarb to hold off on a repo rate hike at the conclusion of its last MPC meeting of the year on Thursday.

“The dispersion of inflation in the consumer basket remained low in the October inflation release. Only three out of the 28 inflation categories experienced inflation in excess of 6%. These categories included food, private transport and electricity,” she noted.

“Although higher fuel costs should drive inflation higher in the near term, services constitute around half of SA’s inflation basket and lower price pressures in this component of the basket [including medical aid tariffs and rental inflation] will likely continue to provide an anchor for headline inflation in 2022,” she adds.

“In our view, contained inflation and longer-dated inflation expectations [which remain close to the midpoint of the target band] could allow the Sarb to stave off rate hikes until the first quarter of 2022,” said Packirisamy.

Read: Resurgence of inflation to push interest rates higher

“With financial markets having already partly priced in tapering by the US Federal Reserve, it is less likely that emerging market assets will have a similar experience akin to the 2013 Taper Tantrum,” she explained.

“We believe the medium-term profile for inflation should afford the Sarb additional time before commencing the interest rate normalisation cycle and adhere to our view for the first interest rate hike to take place in the first quarter of 2022,” she reiterated.

“Nevertheless, we acknowledge that risks to an earlier [November 2021] hike have increased. In light of higher short-term inflation pressures resulting from food and fuel, the Sarb may opt to act pre-emptively to keep inflation expectations anchored,” Packirisamy conceded.

BNP Paribas South Africa senior economist Jeff Schultz on Wednesday anticipated a hike in the repo rate ahead of the festive season.

“We expect the Sarb to raise rates by 25 basis points (bp) to 3.75% for the first time in three years at its final MPC meeting of the year on Thursday,” Schultz said in a statement.

“The decision will be closely contested though, given the lack of meaningful core inflation pressure and an uneven growth outlook. We expect a 3:2 split in favour of a hike [by Sarb’s MPC]. Careful prudence and some materialising upside risks to CPI mean we stick to our call for policy rates to end 2022 at 4.75%, up 125bp on current levels,” he added.

Schultz believes that the Sarb will continue to advocate a “gradual” normalisation cycle with inflation largely under control.

Read: Can we expect an interest rate hike in November?

“Fuel inflation increased by 0.1% between September and October and prices remain elevated relative to the same period last year, rising by 23.1% y/y from 19.9% y/y previously,” FNB economist Koketso Mano said in an industry note following the release of the October inflation figure.

“Inflation should be higher in November, with fuel inflation providing significant upward pressure after the R1.21 per litre price hike… We project headline inflation at 5.5% in November and still 4.5% on average for 2021,” she added.

“Fuel price inflation remains a great source of near-term risk, with some analysts predicting prices breaching the R20 per litre mark by year end given a weaker rand and elevated Brent crude oil prices,” warned Mano.

She said the October inflation “print” will be another piece of information affecting the starting point of inflation forecasts at the MPC meeting this week.

Agreeing with Schultz’s sentiments, Mano added: “We expect the Sarb to hike by 25bps on Thursday, but still follow a gradual hiking cycle in support of the ongoing economic recovery.”