On the release of the latest headline inflation figures for July 2023, many commentators — including the governor of the Reserve Bank — made much of the drop in the number.
In the case of the Bank, the implication was that the recent increases in the repo rate it had instituted had had the desired effect of decreasing the inflation rate.
Now, the only measure which directly reflects the change in prices for the predetermined basket of goods monitored by Stats SA is the consumer price index (CPI). The rate of inflation is a secondary measure calculated from the CPI, but is not uniquely determined. In fact, there are a number of alternatives which can be used as measures of inflation for the same CPI series.
Still, the main method used by commentators and economists in calculating inflation for the CPI is the year-on-year inflation figure of the CPI. This “headline” inflation rate is calculated as the percentage change of the current monthly value of CPI from the value of the CPI for the same month of the previous year.
The problem with calculating inflation from the underlying CPI data in this way is that a year can be very long time for an economy
The problem with calculating inflation from the underlying CPI data in this way is that a year can be very long time for an economy, and it is highly possible for the trend in prices, or other key variables, such as GDP, to reverse their path.
Another measure of the rate of inflation, which avoids this problem, is the so-called month-to-month rate of inflation. This is calculated as the percentage change of the CPI in any particular month from the CPI of the previous month, expressed as an annualised rate.
We calculated the headline inflation figure and the month-to-month (annualised) inflation rate for the period December 2021 to July 2023. The latest available headline inflation figure for July 2023 is calculated as 4.7%, a drop from the figure given for June 2023 of 5.4%, itself down from the figure of 6.3% for May. However, a conclusion that inflation is trending downwards over the past three months may be misleading.
In fact, the CPI rose from 109.8 in June 2023 to 110.8 in July, a large monthly increase of 0.9% — equivalent to an 11.5% annualised rate; this after a June month-to-month jump of 2.2%. So how was it that the underlying CPI can give rise to two measures of inflation with such seemingly contradictory trends?
If you look at the table, the key insight is that the previous year’s values for the CPI for May, June and July 2022 represented high monthly increases of 8.5%, 13.6% and 20.1%, at annualised rates. As the headline inflation rate is calculated as the current monthly value of the CPI relative to the CPI of the same month of the previous year, it is equally dependent on the previous year’s base value as it is on the current value.
Therefore, it is the high and sharply rising values of the CPI in May, June and July 2022 that have heavily (downwardly) biased the measure for headline inflation for the months of May, June and July 2023, leading to the values 6.3%, 5.4% and 4.7% respectively.
Headline inflation in South Africa is therefore more likely to be on an upward, rather than a lower, trajectory
Looking ahead to the August 2023 figure, the headline inflation rate is likely to increase too, because the August 2022 base CPI value is 106, only slightly up from the July 2022 value of 105.8.
In fact, headline inflation in South Africa is therefore more likely to be on an upward, rather than a lower, trajectory.
So what now? Any inflation or growth rate measure needs to be treated with circumspection; there is no uniquely best way to measure the growth rate of some underlying economic time series. In the case of inflation, the year-on-year percentage change of monthly CPI is typically used because it does not change much from month to month. In contrast, in the case of real GDP growth, the much more variable quarter-to-quarter annualised percentage change is generally used rather than the year-on-year change.
The key issue observers and policymakers need to be aware of is that very different inflation rates (or growth rates in the case of real GDP) can be calculated using the same underlying series.
In the particular case of July 2023 headline inflation, it is certainly inappropriate to conclude that for the that month there has been a slowdown in price increases; any careful study of the actual CPI data can only lead to the opposite conclusion.
From an economic standpoint, demand-side pressure on prices in South Africa will remain subdued, given the weak state of the economy and the level of interest rates.
Price changes over the next few months will depend much more directly on supply forces well beyond the influence of interest rates, such as the exchange value of the rand and the price in rand of a barrel of oil.
* Barr is emeritus professor of economics and statistical sciences at UCT; Kantor is head of the Investec Research Institute and emeritus professor of economics at UCT
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