Retail spending has gathered momentum. Have we reached a (low) peak in the retail cycle?
The volume of retail sales in South Africa has gained momentum, off a very weak base. By March real sales were up 4.8% compared to a year before. Will this cyclical recovery in spending at retail level accelerate or fall back? The answer will depend on the future path of inflation in SA, to which short term interest rates and the cost of credit for households and firms are linked. The future path of the rand will be critical to the inflation outcomes, as we discuss below.
This growth in spending was stimulated by a sharp decline in retail inflation from early 2017 (see figure 1 below). Retail inflation in March 2016 was 7.4% and declined steadily to 1.6% in March 2018. Retail sales growth was a negative 1.7% in December 2016. Growth in sales a year later was over 5%. The real sales cycle was at a trough when the retail price cycle was at its peak in Q4 2016.
(Retail inflation is calculated as the annual change in the retail price deflator, being the ratio of retail sales at current prices to retail sales at constant prices. It has fallen far below headline CPI inflation that was 3.8% in March 2012.)
A large part of the answer to whether or not the retail recovery will accelerate or decelerate will depend on the direction of retail prices and on interest rates that will take their cue from the price trends. As may be seen in figure 1, the time series forecast is for a slowdown in sales growth from its peak and a modest pick-up in retail inflation from its recent trough. It will take rand strength to avoid these outcomes.
In figure 2 we show this clearly negative relationship (inflation up and sales growth down) over an extended period. It also shows how low the current rate of real sales growth is in comparison to the previous peak growth rates realised in 2006 and 2011. There would be little reason to regard the current rate of retail sales growth as representing a peak in the cycle – were it not for a concern that retail price inflation may have reached a cyclical trough.
The declining trend in retail and headline inflation since mid-2016 had much to do with the stronger rand. Another force acting particularly on food price inflation was the end of the drought in the eastern part of the country of 2016. The drought had pushed food price inflation to double digits. Food price inflation was 3.5% in March 2018. Inflation peaked after the USD/ZAR exchange rate had reached its weakest point in late 2015. And headline and retail inflation receded after the rand had come to strengthen on a year on year basis. Thus the future of inflation in SA will depend, as ever, on the exchange rate, given the openness of the economy to foreign trade. Exports and imports together add up to the equivalent of 60% of GDP.
We compare CPI (headline) inflation with retail price inflation in figure 3 below. We show the impact of the exchange rate on inflation in figure 4.
In figure 5 we compare the correlated movements in the USD/ZAR and trade-weighted rand. Both rand exchange rates are helpfully for inflation trends that still marginally stronger than they were a year ago, even after recent US dollar strength and rand weakness.
The key to the exchange value of the rand in the months to come (and so for the outlook for inflation) will be the behaviour of the US dollar. Dollar strength vs peers is likely to mean weakness in emerging market currencies, including the rand, as has been the case since mid-April. Dollar strength in 2014 was associated with emerging market currency weakness until mid-2016. A degree of dollar weakness, and rand and emerging market strength followed until very recently. It may be seen that since April 2018, renewed dollar strength vs the euro, yen, sterling and the Swiss franc has been associated predictably with emerging market and rand weakness.
The degree to which the rand moves independently of the other emerging market exchange rates as shown in the figures may be regarded as the additional SA-specific political events that can influence the exchange value of the rand. SA risks weakened the rand compared to other emerging market currencies in 2015 – and a diminished sense of SA-specific risks to investors strengthened the rand in a relative sense in 2016 and again in late 2017.
Thus it should be appreciated that most of what happens to the rand will reflect global forces acting on emerging market currencies generally, events over which SA has no influence. Nor are SA interest rates likely to influence the rand exchange rates in circumstances when global capital flows dominate exchange rate movements. In our view, with the Ramaphosa presidency now firmly in place, the exchange value of the rand in 2018 will be influenced largely by what happens to the US dollar and all emerging market currencies.
The recent strength of the US dollar is a clear danger to the rand and SA inflation. A stronger US dollar means rand weakness and more inflation in SA and at best stable short-term interest rates. More inflation and unchanged interest rates will hold back retail sales. A weaker dollar however would mean less inflation, possibly lower interest rates and continued strength in retail sales volumes.
The dollar strengthens when the US economy grows faster than other developed economies and vice versa. Relatively faster growth in the US means that US interest rates are likely to rise relatively to interest rates in Europe and Japan, so attracting flows into the dollar, as has been the case recently. More synchronised global growth is to be hoped for to restrain dollar strength and protect the rand and improve the outlook for inflation and growth in SA.
SA has little influence over the direction of the rand and hence inflation and the retail sales cycle. The best SA monetary policy can do in these circumstances is to let interest rates take their direction from the state of the economy and not the outlook for inflation – which is dominated by forces beyond interest rate influence. The danger to the economy comes from interest rate settings that react to the impact of a stronger US dollar on domestic inflation. 23 May 2018