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South Africa Inflation and Fixed Income Summary (24 January 2018)

Core Content

The document provides an analysis of South Africa's December 2017 inflation data, along with a forecast for the remainder of 2018 and implications for the Fixed Income market. It is authored by Deutsche Bank economists and strategists, including Elina Ribakova, Twisha Roy, and Christian Wietoska.

Key Inflation Data

• December YoY Inflation: Rose slightly to 4.7%, bringing the full year average to 5.3%, which is within the South African Reserve Bank (SARB) target range of 3% - 6%.
• December MoM Inflation: Increased by 0.5%, the fastest rise in three months.
• Core Inflation: Increased by 0.3% MoM, also the fastest rise in three months.
• YoY Core Inflation: Declined by 0.2pps to 4.2% due to a higher base effect.

Drivers of Inflation

• Transport Costs: Increased by 1.0pps to 1.5% MoM, driven by higher petrol and public transport prices.
• Fuel Prices: Rose to 6.4% YoY in December, up from 4.4% YoY previously.
• Wages: Economy-wide wage growth contributed to increased service costs, particularly affecting domestic workers.
• Housing Costs: Increased by 0.4pps to 0.4% MoM, influenced by rising house prices and rental costs.

YoY Inflation Trends

• Food Prices: Continued to decline, reaching a 25-month low of 4.9% YoY.
• Household Maintenance Costs: Increased by 0.5% MoM, reversing a previous decline.
• Housing Costs: Also showed a decline in YoY terms, despite monthly increases.

Inflation Forecast

• 2018 Annual Average Inflation: Expected to be 4.8%, with a likely 4.2 - 5.5% range.
• Year-End Inflation: Projected to rise to 4.6% YoY.
• FX Pass-Through: Estimated at 10-15%, though the authors believe this might be on the higher side.

Fixed Income Strategy

• Trade Recommendation: Be long on R2030 (entrance: 9.17, current: 8.88, target: 8.50, stop: 9.50).
• Short-End Rates: The authors note that the current 1Y1Y rate of 6.85% appears slightly too low given the 4.7% inflation.
• Expected 1Y1Y IRS: Based on DB forecasts, it is 6.82% for Q1 2018.
• Market Expectations: There is no significant dislocation in short-end rates at this time.

SARB Response

• The SARB may consider rate cuts due to the expected decline in inflation, but the authors caution against an aggressive easing cycle.
• Factors Affecting SARB Decisions:
  • Gradual increase in inflation pressure from Q2.
  • Improved growth dynamics.
  • Higher energy prices.
  • Difficult wage negotiations.
  • Higher global core rates.
  • Cautious SARB stance.

Risks and Considerations

• Inflation Expectations: Remain anchored at 6%, which could feed into headline inflation.
• Credit Rating Downgrade Risk: A potential downgrade of South Africa by Moody's could lead to forced selling of government bonds, negatively affecting the rand and thus inflation.
• Market Sensitivity: Fixed-income instruments are sensitive to macroeconomic shocks such as inflation, FX depreciation, and fiscal changes.
• Indexing Risks: Indexed cash flows may lag or mis-measure actual movements in underlying variables.

Additional Notes

• The report includes important disclosures regarding the source of data, potential conflicts of interest, and the nature of the recommendations.
• Legal and Regulatory Information: Provided for various jurisdictions, including the United States, Germany, United Kingdom, Hong Kong, India, Japan, Korea, Qatar, Russia, Saudi Arabia, UAE, Australia, and New Zealand.
• Analyst Certifications: The views expressed reflect the personal opinions of the lead analysts and are subject to change.
• Research Independence: The Deutsche Bank Research Department is independent of other business divisions.

Conclusion

The inflation in South Africa is expected to decline in the short term due to base effects and a stronger rand, but will gradually rise from Q2 onwards. The Fixed Income market is advised to maintain a long position on R2030, with a cautious outlook on SARB policy responses. The report emphasizes that while inflation remains a key factor, market expectations for rate cuts may be overreacted, and the short-end of the curve is not necessarily undervalued.