Is there a chance for interest rate cut in September given low inflationary pressure?

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By Tebogo Mashabela (Agricultural Economist)

Farm and factory-gate inflation, as measured by the annual change in the producer price index (PPI) for final manufactured goods, declined to its lowest level in five months in July 2019. Producer inflation slowed more than expected to 4.9% year-on-year (y/y) in July 2019, from 5.8% in June 2019. The consensus forecast for the inflation rate for final manufactured goods by economists polled by Bloomberg was 5.6%, and as such the 4.9% actual outcome was therefore significantly lower than expected.

The deceleration in producer inflation in July 2019 was largely due to lower fuel prices. The fuel producer price component has consistently been the largest contributor to the headline PPI reading. In July 2019, petrol prices dropped substantially for the first time in six months by 95 cents per litre due to a large drop in international oil prices.

Source: Stats SA

The producer inflation rate for agriculture, forestry and fishing accelerated, albeit modestly to -1.1% level in July 2019, from -1.9% in June 2019. The food producer inflation also accelerated to 6.1% in July 2019, from 5.7% in June 2019. This is, in fact, the highest such figure recorded since May 2017.

Part of the producer price food inflation increase is statistical in nature following the stagy decline in food inflation a year ago as the economy emerged from severe drought and the supply of food became more abundant again. It is also partly a function of a recovery in meat prices as the meat market returns to normality in the wake of the drought conditions of the past year as well as the outbreak of foot and mouth disease.

The producer inflation rate for meat and meat products accelerated to 2.2% in July 2019, from 0.3% in June after having risen progressively from a low point of -6.1% in January 2019. While producer inflation in most food products across categories accelerated from June 2019 levels, producer price inflation of grain-related products surprisingly decelerated to 11.8% in July 2019, from 13.0% in June 2019.

The recent acceleration of food producer inflation witnessed in July 2019 will have a negative effect on food inflation in the coming months, which eased more than expected from 4.5% in June 2019 to 4.0% in July 2019. In addition, the latest increases in fuel prices in August and September 2019 will, in fact, exert some upward pressure on food inflation in the short term.

In its last meeting in July 2019, the South African Reserve Bank (SARB)’s Monetary Policy Committee (MPC) clearly stated that food prices remain key risk to the inflation outlook this year and early next year. The latest acceleration in food consumer and producer inflation in July 2019 should, therefore, be a worrying concern to the MPC.

Can we expect an interest rate cut in three weeks’ time?

Producer inflation partially foreshadows consumer inflation, which is the key benchmark used by the MPC in deciding on interest rate increase and/or cut. However, the relationship is not perfect, as producers often can absorb price pressures to retain market share.

This can be seen with the latest data on consumer and producer inflation which clearly shows that retailers have not been able to pass on significant price increases to consumers. Businesses are just not able to pass on cost increases in the manner possible a year or two ago. A weak demand environment continues to hinder the transfer of costs further down the chain as retailers are finding it hard to pass the costs to consumers due to weak buying power.

Given that both consumer and producer inflation decelerated by even more than had been expected, there is 50-50 chance of a second consecutive interest rate cut at the forthcoming MPC meeting from 17th to 19th September 2019. The latest inflation numbers (i.e. both producer and consumer inflation) confirm that there is very little inflationary pressure in the wobbling South African economy. In addition, global monetary policy has inclined towards a materially softer stance in the wake of the escalation of the global trade war. As such, this together with little inflationary pressure could help support a rate-cut decision by the MPC in September 2019.

On the other hand, the MPC may place more weight on future price changes before deciding on the rate cut. For this reason, it might take a wait and see approach thus leaving rates on hold in September given the uncertain trajectory of the rand. It might retain a cautious policy stance, in view of the recently marked rand depreciation.

Tebogo Mashabela is an Agricultural Economist by profession with two master’s degrees, Master of Science (MSc) Agricultural Economics and Master of Business Administration (MBA).

Is there a chance for interest rate cut in September given low inflationary pressure?
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