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I still believe the Reserve Bank will have scope to start with repo rate cuts early in the second half of this year, but the monetary policy outlook has become more complicated.

Where before I was concerned about the dramas brewing with respect to offshore rates — read: the US and its supercharged economy — local inflation dynamics also create reason for worry.

My date for the first cut remains the July meeting. By then elections, the cause of much angst in financial markets, will be in the rear-view mirror. Hopefully the market’s worst fears will not be realised.

At least one of the Group of Three (G3) central banks, most likely the European Central Bank, will have also started easing, giving the Reserve Bank comfort that lower rates can be tolerated by the markets. That said, my conviction around this view is being challenged, most recently by price developments in domestic services.

Movements in consumer inflation are typically dominated by price changes in food and fuel, which make up about a quarter of the basket. Because these components are volatile, mostly because they are influenced by the rand, they tend to dictate how volatile inflation is over time. The other three-quarters of the basket is made up by so called core inflation, which includes everything other than food and fuel.

The core part of the inflation basket comprises goods and services. Core goods are physical things you can buy, including clothes, vehicles and similar products. They make up just under 20% of the inflation basket. Goods are often imported in whole or in part, and prices here are heavily influenced by movements in the value of the rand.

Services make up 55% of the inflation basket. Core services inflation best illustrates the level of underlying inflation. This component moves slowly, and arguably captures price-setting behaviour outside supply shocks in the economy and the effectiveness of monetary policy over time.

Core services inflation ranged between 5% and 6% from 2011 to 2017. It fell to 3.2% in December 2019 before the Covid-19 crisis, reflective of a monetary policy committee (MPC) that pushed the 4.5% target narrative and acted accordingly, and very low growth in the years before the Covid-19 crisis.

This measure plummeted to an unprecedented 2.3% during the Covid-19 slump, before rising to 5% during the inflation heyday of 2022. As economic activity slowed and the Bank hiked rates, core services cooled to 4.1%.

Core services inflation appears to have rebounded in recent months, driven by a recovery in rentals inflation, which is not yet at pre-Covid levels, and medical aid inflation, which spiked to 8.4% in February. A rebound in this subset of prices, which make up more than half of the inflation basket, bears close watching.

In theory, price setting should be influenced by underlying demand conditions, and inflation should be responsive to the strength of the economy. Central banks rely on this as an important monetary policy transmission channel. However, not every product or service is price sensitive. Healthcare is such a product. People will not stop spending on medical aid, even if it is expensive, when there are no alternative ways to access quality healthcare.

The other sticky part of the inflation basket is administered price inflation, which covers products whose prices are set by regulators, including municipal rates. These prices are insensitive to market forces and inflation here is now at about 8.4%.

The relative stickiness of prices that are unresponsive to consumer demand — and thus arguably monetary policy — could tie the MPC’s hand when the next policy decision has to be made.

• Lijane is global markets strategist at Standard Bank CIB.

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