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Beware the CPI trap!

14 June 2021 Gareth Stokes

There is nothing like a good inflation outlook debate to get economists and financial analysts fired up. Many who watch the US financial markets are adamant that the combination of fiscal stimulus and post-pandemic demand and supply factors will result in a sharp spike in consumer inflation in that country, with all manner of nasty side effects, not least of which higher interest rates. On the domestic front, the outlook for inflation is more benign. Statistics South Africa reported a below expectation 2.9% year-on-year growth in consumer price inflation (CPI) for February 2021, expanding to 3.2% growth year-on-year for March.

Commenting on February’s numbers, audit firm PWC said that consumers found themselves in a “very favourable retail price environment”. A closer assessment of the basket of goods and services that make up the CPI showed above average increases in public sector transport costs (+4.5%) on the back of higher fuel costs, with diesel up 56c/litre and petrol 65c/litre due to a spike in international oil prices. On the disinflation side, consumers benefited from the decision by many medical schemes not to hike premiums in the first half of 2021, with the insurance part of the CPI basket only coming in 4.1% higher, year-on-year, February 2021. Medical scheme members will be enjoying the brief respite; but can expect increases from July of this year. 

Comment on March’s numbers, Johann van Tonder, economist at Momentum observed that fuel, food, housing and education inflation were beginning to exert upwards pressure on the CPI basket. 

Why should you care about inflation?

You can think of inflation as a thermometer for the prices that consumers pay for a basket of goods and services. Positive inflation, which exhibits as consumers paying more for the same basket of goods and services over time, has a negative consequence of eroding income and living standards. Inflation has a tendency to be self-fulfilling, in that higher inflation places pressure across the economic and financial system. 

Financial advisers keep a close eye on inflation because it is a key consideration in all aspects of financial analysis and economic decision-making. From a financial planning perspective, inflation erodes the future value of your clients’ cash. Asset managers, financial advisers and retirement fund trustees are thus painfully aware of the need to generate real or after inflation returns for investors and fund members to grow their wealth. 

Price stability is considered an economic imperative by most countries, with this being achieved through sensible fiscal and monetary policy. The South African Reserve Bank (SARB) operates an inflation targeting monetary policy aimed at keeping headline inflation in a 3-6% range and can intervene in the financial markets by raising or lowering interest rates in response to supply and demand, with inflation being one of the measures of these forces. It can lower inflation by increasing interest rates and thus reducing the demand for goods and services. Or it can stimulate the economy by lowering interest rates. 

Firmly within the target range

Local inflation has remained within the SARB’s target for some years, and looks set to remain there over the short-term. “Headline CPI is expected to breach 5% in the next quarter on the back of higher fuel and administered prices,” said Van Tonder. “However, as the average headline CPI for 2022 and 2023 is expected around the 4.5% mark targeted by the Monetary Policy Committee (MPC), the repo rate is expected to remain unchanged this year”. This does not mean that consumers will side-step the effects of higher prices. 

Fuel price inflation is like kryptonite to South Africa’s agriculture and transport sectors. Paul Makube, senior agricultural economist at FNB Agri-Business said that grain producers and logistics companies in the agriculture value chain will feel the pain [of higher diesel and petrol prices] as close to 80% of South Africa’s grain is transported by road. Livestock and horticulture with citrus harvest in its infancy will also be affected in terms of distribution across the country and for exports. Moreover, the prices of derivatives of crude oil processing such as fertilizer, herbicides and pesticides are likely to increase should the recent uptrend persist. 

What happens next?

Inflation could jump sharply in the second half of 2021. An article by Lullu Krugel, Chief Economist for PwC Strategy& Africa and Dr Christie Viljoen, PwC Strategy& Economist noted serious concerns about retail prices, electricity and other administered prices. Indeed, the Gauteng High Court ruled in February that Eskom will be able to lift its tariffs by more than 15% this year. 

The electricity price spike has caught the attention of FNB, who issued a media statement on ‘the financial impact of double-digit electricity increases on entry and middle-income households’. According to FNB Insights, electricity is one of the largest expense categories for entry to middle income customers who will have to review their monthly budgets to accommodate the increase. Interesting statistics by FNB customer account types show a 9% to 15% increase in average monthly electricity spend between 2019 and 2020. 

The SARB warned in March that the next change in interest rates would be upward; but PWC is of the view that the fragile nature of the economic recovery will prevent them from lifting interest rates in the months ahead and quite possibly delay a start to policy normalisation until early in 2022. In fact, by 22 May the key lending rate or Repo rate, will have been below 4% for a full year. And that is good news for the country’s post-pandemic economic recovery. We conclude with comment from economist Mike Schussler who writes in that “the extended low interest rate outlook should encourage more risk-taking by firms.” 

Writer’s thoughts:
An investor or saver who fails to grow his or her assets at a rate greater than inflation will end up going backwards… In other words, the money they invest today will be worth less in five, 10 or 20 years. But inflation also impacts on other areas of financial planning, such as the sums insured on death, critical illness and disability policies. Could you comment on how inflation impacts on your financial planning processes? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].



Added by Gareth Stokes, 15 Jun 2021
Thanks Humphrey & Garrick for your comments… Much appreciated. I had to quickly re-read the article and must concede, in this case, to have waffled on about inflation. I assure you that my personal experience with inflation is similar to yours. I should have included a paragraph on the published rate versus the experienced / perceived rate and then perhaps asked: “How do you accommodate your client’s on-the-ground experience of inflation in your financial planning”.
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Added by Humphrey, 14 Jun 2021
Garrick you beat me to it. Personally i do not believe the figures released by this government - like everything else they have touched is either destroyed or in seriously bad shape. The figures (statistics) are manipulated in my view (either things are put in the "basket" to make it look good or the figures are just plain jippoed).

Besides medical aid (for once), as a man in the street i am seeing 10% or 10% plus (10% on my school fees, 10% on my linked alarm, 15% on electricity and on food - oh my goodness, the packets my wife returns with are containing less and less goods for the allocated food budget. Retailers are also sneaky - they reduce the grams or liters of a product but do not reduce the price - this is an additional hidden inflation factor.

Then you pay ever increasing taxes but receive less and less each day. This means ever increasing other costs like private schooling, medical, security companies, our area are now paying for concrete to fill potholes, now i have to install an inverter and solar panels, also installing water tanks because of poor water quality and lack of planning to ensure adequate water in our area - and the list goes on of additional costs.

So we have real inflation that the man in the street experiences and then we have the "official" inflation rate. In South Africa, as individuals we are going financially day by day.
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Added by Garrick Bergh, 14 Jun 2021
I just love these inflation articles. They truly make no sense at all. On one hand we have writers waffling on and quoting 'official' figures. On the other hand any consumer who is not actually blind can see for themselves how fuel, electricity (when actually supplied!) and food gallop along at levels up to 3x (electricity) the 'official' inflation rate. Compare these numbers to salary increases in the private sector and you quickly understand why debt continues to grow,
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