Why inflation’s frantic pace will slow this year

The environment globally and domestically in 2022 was one of high inflation and rising interest rates in the main, causing concern to financial markets as economic growth slowed.

The cost of living climbed rapidly, with inflation a measure of the pace of increase in prices compared with a year ago. This came on the back of the Russian/Ukraine war, which caused shortages of grains and agricultural inputs — after a few years of rising prices because of the effects of climate change — while oil prices rose on higher quotas.

The rand weakened over most of 2022 as investors became risk averse, selling holdings in perceived risky assets in favour of safe haven assets. That led to the strengthening of the US dollar.

Higher interest rates negatively affect economic growth, and just the expectation of higher interest rates typically has an adverse effect on investor appetite for risk. When global commodity prices rose sharply in February 2022, inflation expectations increased suddenly, causing investors to anticipate a sharp rise in interest rates and so a marked slowdown in economic growth and equity performance.

This year inflation is expected to fall and could do so more rapidly than expected, with financial markets positive on the prospects. Previous expectations of a severe global recession are abating and there are even hopes now of a recession being avoided.

The most recent readings show that while inflation eased by the end of 2022, it was still high, well above the 4.5% midpoint of SA’s target range (and typically above target measures of most countries).

The consumer price index (CPI) is likely to see a downward trend over the first half of 2023 as base effects drive down the inflation rate. Rapid price increases in 2022 will not be matched in the first half of 2023, which is expected to see a weaker inflation environment. The global economy is expected to remain weak, recovering in the second half of 2023.

Note that inflation readings are typically annual measures. Price changes versus the month before are also of interest, but central banks look at the annual measures specifically in monetary targeting. The SA Reserve Bank, for example, seeks to maintain CPI inflation between 3% and 6% year on year, while the latest reading was at 7.2%. That was in December, having dropped from 7.8% in July.

The first quarter of 2023 is expected to see weakening in economies, led by Europe, China and the US, though concerns over a severe global recession have fallen away, as noted above. The US has slowed, but not yet stopped, its interest rate hike trajectory, but other economies are expected to (eventually) follow this cooling in the interest rate hike cycle.

This quarter is expected to be weaker growth-wise in SA too, as higher interest rates bite into the middle-income sector of the consumer base, which is financially vulnerable.

We forecast CPI inflation at 5.3% year on year over 2023 for SA, after recording 6.9% for 2022. Inflation has been sticky on the downside so far, globally and domestically, but the first half of 2023 is expected to see inflation measures drop more rapidly, with SA reaching the midpoint of its inflation target potentially in July.

After this, however, the second half of 2023 is likely to see a flattish inflation environment, with SA’s CPI inflation rate running at about 4.5%. But risk factors persist to all the forecasts, particularly higher commodity prices from a quick China reopening.

While the Brent crude oil price has averaged $57 a barrel since 1995 and $65 since 2000, from 2018 Opec+ further limited supply to maintain a price closer to $70 barrel. Now, since the pandemic, it is attempting to keep it nearer to $90.

Inflationary pressures globally would have been more subdued if the upwards pressure on oil prices after the pandemic had been limited to about $70, with Opec+ failing to drop quotas (and so increase oil supply), which would have weakened inflation 2022.

Overall, 2022 proved turbulent, with the Russian/Ukraine war a black swan event that pushed up inflation and interest rates by a lot more than initially expected, and the rand was much weaker. The black swan of the Covid-19 pandemic did the opposite for inflation and interest rates, but saw a weaker rand.

The inflation outlook contains uncertainties, and central banks still have a path ahead before feeling confident that inflation is back under control. While we believe inflation will settle back within, or at, target/s sooner than expected, there are many risks and, as at the start of any year, many uncertainties.

THE SECOND HALF OF 2023 IS LIKELY TO SEE A FLATTISH INFLATION ENVIRONMENT, WITH SA’S CPI INFLATION RATE RUNNING AT ABOUT 4.5%