EMEA Snap:South Africa,Inflation declines for now,but upside
Inflation in transportation costs has slowed on the back of a lower monthlyincrease in fuel prices as well as personal vehicle operating costs, falling to 5.4%YoY in October (from 5.6% YoY previously). Annual inflation in food prices havealso declined to a 23 month low of 5.3% YoY on the back of a higher base, despitethe monthly increase in prices. However, a lower base in housing costs, meantthat despite the monthly fall, annual inflation has increased to 5.1% YoY (from4.9% YoY).
Investor questions this month centered on bank recapitalization, possibility of lowering inflation target (unlikely according to the CBR), and fiscal policy rule (allowing for more sterilization as the new rule takes FX forecast out of the equation) at the recent IMF meetings. While we do not expect a new wave of significant inflows and, therefore, significant Ruble appreciation, we believe investors will continue to invest in Russia as their allocations to EM increase. Nearly 5% real rates, using OFZ as a benchmark, economic pick-up, sound fiscal policy and a healthy current account surplus all speak in favor of Russia. Risks remain related to the US sanctions report on SOEs and sovereign debt due in early February and sharp oil price movements.
Upside risks remain. Although at a historical low, sticky inflation expectations remained constant at 10.3% in June, and continued seemingly elevated, compared to headline YoY inflation. The CBE has noted before that public expectations of prices are influenced by the price of staples, and hence higher food inflation could slow down the convergence of households’ expectations towards actual levels. A faster-than-expected recovery in domestic demand also remains a risk to inflation. In addition, we had flagged in earlier publications that the general downward trajectory in consumer prices may momentarily see upside risks from mounting exchange rate pressures. The exchange rate began to depreciate in June, and weakened by 4.6% through the month. Moreover, seasonal variations on the C/A, and a still dovish central bank, will remain points of pressure for the exchange rate through the rest of the year. We expect the exchange rate to continue depreciating to reach 59.5 by end-2017 (currently 60.1).
Headline inflation has been declining since April this year, led by lower food prices,a smaller increase in electricity tariffs than previously, a strengthening exchangerate and falling ULCs. Despite the spike in inflation in August and September,mainly due to higher housing costs and higher petrol prices, we expect inflationto decline further to 4.3% by year-end. However, risks to our inflation forecasts liefirmly to the upside for this year and in 2018. Credit downgrades in November andpotential outflows would impact core inflation via renewed currency depreciation.
In September data, monthly earnings and IP disappointed. September real wages data at 2.6% YoY surprised on the downside even as August data was revised downwards by a large 1.3pps. Real disposable income also surprised on the downside as it declined by 0.3% YoY in September. However, retail sales remained strong with a growth of 3.1% YoY (prev. 1.9%). Strong wage growth, improving consumer confidence, lower savings by households induced by declining real rates, improving household credit and declining inflation all are likely to contribute to the strong momentum in household demand in Q3. We have been highlighting that, even though corporate profits have probably reached a peak, past surge has meant that investment growth will likely improve in Q3 as well. In other activity data, the transportation sector data for September was very weak. However, strong retail trade and improving agricultural output along are expected to support growth. September industrial production data also disappointed, falling to 0.9% YoY from 1.5% YoY previously. Industry slowdown has been pronounced this quarter with the Q3 average at 1.1% YoY, 2.8pps lower than the average in Q2.
Prices increased by 0.6% MoM in June (vs. market expectation of 0.4% MoM), the highest monthly increase in five months. This sharp monthly increase in prices led to a reversal in the downward trend of annual headline inflation, increasing to 4.4% YoY (from 4.1% YoY in May). The increase in YoY inflation was led by increases in both food and services inflation this month. Food inflation increased for the third straight month and reached a 7-month high of 4.8% YoY. Food inflation has increased since April, as the effect of the bumper harvest in 2015-2016 fades and it is expected to trend higher due to (seasonal) supply factors. Inflation in services costs also increased, by 0.2pps to 4.2% YoY with costs of housing utilities and transportation being the two major contributors to inflation in this category. On the other hand, alcoholic beverages, tobacco decreased from 6.7% YoY in May, to 6.2% YoY in Jun; clothing and footwear decreased from 5.3% YoY in May, to 5.1% YoY in Jun; housing, water, electricity, gas and other fuels decreased from 5.0% YoY in May, to 4.9% YoY in Jun; household furnishing, equipment & maintenance decreased from 2.5% YoY in May, to 2.2% YoY in Jun; the health component decreased from 4.0% YoY in May, to 3.3% YoY in Jun (a 69.3ppt decrease). Transport decreased from 4.7% YoY in May, to 4.6% YoY in Jun; the education component decreased from 6.9% YoY in May, to 6.7% YoY in Jun; hotels, restaurants and cafés decreased from 3.6% YoY in May, to 3.3% YoY in Jun. Lastly, miscellaneous goods and services also decreased from 3.7% YoY in May, to 3.5% YoY in Jun. Importantly, ROSSTAT's core inflation measure continued to trend lower, as we expected, from 3.8% YoY in May, to another record low of 3.5% (3.45%) YoY in June.
The National Energy Regulator of South Africa (NERSA) is expected to announce its decision on 7th December. If approved, the increase would come into effecton April 1, 2018 for direct customers and July 1, 2018 for municipalities. Theapplication from Eskom is for one year only after NERSA approved a deviationfrom the multi-year price determination methodology.
The CBR decided to cut the key policy rate by 50bps in September. However the CBR remained cautiously hawkish in their tone, as they expressed concern about inflation expectations and medium-term risks on inflation. With below target inflation, we believe that room to ease further exists, despite CBR's hawkish tone. We continue to expect the CBR to ease the policy rate by 2x25bps at the remaining two meetings this year to take the policy rate to 8.00% by year-end. However, with the latest inflation print and our revised forecast of end-2017 inflation undershooting 3%, we think the risk of a 50bps cut at the October meeting has increased.
The CBR had signaled earlier this month that they would like to ensure stability of prices at the 4.0% target and in order to do that it would look at the 12m moving average YoY inflation (currently at 5.4%). Despite the pressures noted above, we believe that there exists room for the easing cycle to continue, although at a gradual rather than front-loaded pace. We retain our call for another 4x25bps in cuts in the remaining meetings of the year.
Annual inflation, has thereby resumed its declining trend, after two months ofincrease and we believe it will reach 4.3% YoY by year-end. Core inflation has alsodecelerated in October by 0.1pps to 4.5% YoY, in line with our forecasts, to postthe lowest reading since July-2012.
The CBR’s recapitalization of two major private banks - Otkritie Bank and B&N Bank - triggered some concerns last month. However, we do not expect these to have any effect on fiscal positions (MinFin not involved) or inflation. Also, we do not think the problem is systemic as the overall banking sector remains healthy with stabilized NPLs, low FX exposure, stable NIMs and healthy loan-deposit ratios.
Russian inflation surprised on the upside in June.
Further risks stem from the request from Eskom to increase electricity tariffsfor 2018-19 by over 18.9% for direct customers and 26.9% for municipalities.
CPI decelerates further, in line with our forecast. A monthly decline in consumer prices along with a higher base, took the headline inflation down to an all-time low of 3.0% YoY. We expect the disinflationary trend to continue on the back of falling food inflation and base effects with annual inflation now likely to reach 2.8% YoY by year-end. However, still un-anchored inflation expectations and a faster-than-expected pass-through from domestic demand expansion pose upside risks. See EMEA Snap - Russia: Inflation deceleration spot on for more details.
The smaller monthly increase in prices in October compared to the 0.5% MoMincrease in the previous month, has translated to a 0.3pps drop in annual inflation.
Housing costs inflation has declined by 0.8pps to 0.1% MoM, led mainly by aslowdown in rents growth. Inflation in transportation costs has decelerated, alsoby 0.8pps, to 0.9% MoM on the back of lower inflation in petrol prices, personalvehicle operation costs and public transportation charges. On the other hand,food price inflation has jumped to 0.8% MoM, the first positive reading in threemonths, with almost all subcomponents posting higher gains in October.
Inflation expectations remain higher than the headline and firmly anchored ataround 6%. House price indicators also show renewed upward momentum.
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