The primary purpose of the South African Reserve Bank (SARB) is to achieve and maintain price stability in the interest of balanced and sustainable economic growth.
Like most other central banks, it targets inflation as its anchor for price stability. Although the SARB targets headline inflation, it also pays significant attention to underlying inflation to get an insight into the longer-term direction of headline inflation, to ensure it can implement appropriate monetary policy.
The reason for this is that headline inflation is susceptible to short-term shocks. It can be volatile, with a high noise-to-signal ratio. Underlying inflation measures are designed to try to filter out these temporary price movements and identify the sticky parts of inflation.
Central banks most often look at core inflation, which typically removes seasonal fluctuations and volatile inputs, such as food and energy prices, and the SARB is no exception. Various other underlying inflation measures have been developed, including trimmed mean inflation, weighted median inflation, PCCI (persistent and common component of inflation), and supercore inflation.
The SARB recently released a special occasional bulletin. Two of the three research papers in the bulletin constructed and presented two inflation measures to help unpack underlying inflation pressures that may not be picked up by the traditional measures such as headline, core, and trimmed mean inflation, which have been the “official” measures that the SARB monitors. Bloomberg reported that both these new measures will be considered, together with Statistics South Africa’s headline and core inflation measures, to inform monetary policy in the future.
One of the measures is supercore inflation, which has received the most attention from the media. Largely following the European Central Bank (ECB) methodology, this new measure is made up of components of core inflation that are highly sensitive to economic conditions. It therefore gives the SARB’s Monetary Policy Committee (MPC) a steer on whether inflationary pressures are supply- or demand-driven.
The other measure presented in the occasional bulletin was the PCCI. The key function of employing the PCCI is to determine persistence in inflation regardless of whether it is driven by supply-side or demand-side pressures.
More on the new inflation measures
The indices in supercore are a subset of core inflation – the analysis uses disaggregated CPI data at Classification of Individual Consumption According to Purpose (COICOP) level three. COICOP is the international reference classification of household expenditure. It uses 40 log-transformed quarterly indices. For each of the indices, three Phillips curves are estimated, which respectively include the output gap lagged by a quarter, two quarters, and the third, a combination of both lags.
Based on the outcome of the authors’ modelling, 11 components showed statistical significance to the output gap. The three largest components in supercore are rentals, water and other services, and household content – these are heavily skewed towards services.
Supercore showed that demand-driven inflationary pressures were balanced over the prior year.
PCCI is a non-exclusion-based measure and therefore no information is lost. It uses factor modelling as a dimensionality reduction technique. No macroeconomic assumptions are made.
PCCI being higher than core inflation is mainly reflective of below-average post-pandemic housing inflation and medical inflation.
To be useful to monetary policy decision-making, both these measures must be less volatile than headline inflation and give insight into the direction of headline inflation. The MPC targets headline inflation and none of these measures (including core inflation).
However, the new measures can help to provide a better picture of the balance of risks to the inflation outlook. If the measures show elevated and persistent inflation despite low headline inflation, the MPC could delay a rate-cutting cycle. Conversely, if there is higher headline inflation, but persistent inflation pressures are subdued, it might provide room to maintain the current policy stance.
Even though headline inflation is well behaved (4.6% in July), and core inflation is at 4.3%, both new measures indicate that there are some underlying inflation risks. In our view, this means that at its September meeting, the MPC is likely to be cautious and will cut only 25 basis points (bps). The market is pricing in a maximum cycle of 100/125bps of cuts, without any large moves. Although there is room for rates to move lower, these new measures currently point to a slow and steady pace of cutting.
Sisamkele Kobus is an economics analyst and Vivienne Tabererer is an investment director at Ninety One.
Disclaimer: The views expressed in this article are those of the writer and are not necessarily shared by Moonstone Information Refinery or its sister companies.
