Headline inflation, ZAR volatility and demand lead to SARB’s monetary tightening

The source of lower than expected inflationary pressures remains unclear. Exchange rate depreciation and a significantly undervalued rand should be pulling inflation back above 5%. Nevertheless, the latest reading for August was below expectations at 4.6% y/y against 4.8% y/y for consensus.

The slack in the job market could be partially to blame. Power consumption is also declining, which should be a boon given the ESKOM debacle and its constraints.

Core inflation remains at 5.3% y/y, suggesting the impact of lower commodity prices on headline could be transitory. We believed SARB would follow up with an additional hike at its September meeting after the surprising decision to hike in the previous gathering. We did not expect that inflation data out the day of the decision would be released as low as it was.

We believe that exchange rate pass through may raise inflation later this year. SARB will likely therefore tighten an additional 25 bps at the November 19th monetary policy meeting.

Currency volatility will likely be to blame on the decision. SARB's FX reserves holdings remain insufficient to stave off excessive positioning at extreme daily trading behavior.

The key critical factor tilting the SARB either way will be Q3 preliminary activity data. There is a high probability of negative growth as a result of weak external and domestic demand.