Higher electricity tariffs stand in the way of inflation normalising in 2023

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After breaching the top end of the African Reserve Bank’s 3%–6% target band last year and hitting a 13-year high of 7.8% year-on-year in July, consumer inflation appears on the retreat, although the outlook for 2023 remains uncertain.

The latest data released by Statistics South Africa (StatsSA) on Wednesday showed that inflation cooled for the second consecutive month to 7.2% year-on-year in December from 7.4% the previous month, and economists said it was on a downward trend although the central bank’s monetary policy committee (MPC) would have to stay “vigilant” to get it back to the target range.

At face value, the December inflation numbers are encouraging, said Kevin Lings, chief economist at Stanlib.

“They’re moving in the right direction. If you go back to July last year, that was peak inflation and we’ve come down from that peak. It is moving lower and it should move lower during the course of this year,” Lings said. 

He however warned that upward risks remained.

“With electricity going up by 18.65%, that pushes up the Reserve Bank’s own inflation forecast. When electricity goes up, it causes price pressures in other parts of the economy. Manufacturers now have to pay more, businesses are generally paying more and they have to consider whether to pass on some of those price pressures and there will be that desire but they can’t pass it all on because the economy is weak and the consumer is weak,” Lings said. 

“We expect inflation to be 5% by the end of the year. But at this point, we can’t be confident that that’s going to happen because if electricity prices had increased by 9% instead of 18% then you would have been confident.”

Last week the National  Energy Regulator of South Africa (Nersa) granted Eskom an 18.65% tariff hike to help it cover its debt. 

Investec chief economist Annabel Bishop concurred with Lings that higher electricity costs would hamper the progress of easing inflation. 

“Looking forward, South Africa will see upwards pressure coming from the larger than expected 18.65% increase in electricity prices, with Stats SA typically capturing the annual electricity price increase for CPI inflation in July,” Bishop wrote in a note. 

She added that risks to the outlook included a weaker-than-expected GDP growth rate as severe electricity load-shedding persists this year and a further loss in investor sentiment. 

Without a sharp rise in fuel prices or another shock, inflation could actually drop to 4.3% year-on-year by July from 4.9% year-on-year in June, Bishop said, citing a high base from the comparative year when inflation peaked at a 13-year high due to fuel and food prices. 

Economists at Nedbank forecast inflation averaging around 5.5% for 2023 compared with  6.9% in 2022 and 4.6% the year before. Surging food and petrol prices were mainly to blame last year, due to the Russian war on Ukraine. 

Nedbank said risks to the inflation outlook remain to the upside, emanating mainly from the global oil price, the vulnerable rand and administered prices, particularly electricity tariffs. 

“The National Energy Regulator of South Africa granted Eskom permission to increase electricity prices (and) while this was lower than the 32% hike the power utility wanted, it will still be a significant contributor to inflation. These factors could cause inflation to remain high for longer or recede at a much slower rate,” the bank said. 

Sanisha Packirisamy, an economist at Momentum Investments, said inflation would come back within the target band by the middle of the year and dip just below the 5% mark by the end of the year.

The central bank’s MPC expects inflation to remain above the upper limit of its target range until the second quarter of 2023. The Reserve Bank is expected to continue hiking rates, although at a slower pace, until it is confident inflation will return to the midpoint in its forecast horizon.

The MPC will hold its first meeting of the year next week. It will probably push through another interest rate hike of about 25 basis points, Lings said.

“The MPC will send a message that it acknowledges that there’s been progress in getting inflation under control but there are risks given the electricity hike and therefore it will probably push another interest rate increase, but modest,” he said. 

“They then need to be vigilant because you can’t get complacent that inflation is going to come back neatly into the target. If it does go back neatly into the target then they could cut rates by the end of the year.”

Bishop predicted a 50 basis points increase.

According to Packirisamy, there are a couple of things influencing the monetary policy committee’s decisions right now, among them a weak dollar, which has helped emerging market currencies appreciate.

“The market was looking for bigger increments of about 50 basis points. I would say now the market has shifted and is expecting 25 basis points increments. We think that we’ll probably get a cumulative 50 basis points for the first quarter, so, 25 basis points in January and 25 basis points in March,” Packirisamy said.

“Beyond that, I think you will start to negatively impact growth without having a significant impact on inflation given that in South Africa inflation has been higher because of exogenous food costs, exogenous petrol costs and fuel costs.”