May’s CPI inflation rate surprised to the upside, rising by 6.5% from 5.9% and well above our and Bloomberg consensus of 6.1%. The key driver was a significant increase in the food price index, rising by 2.2%m/m and 7.8%y/y. Most of the sub-food categories recorded large increases, eg. Cereal (+8.4%), meat (+9.4%) and oils and fats (+26.9%). This can be ascribed to the increase in global food prices due to Russia’s war in Ukraine and countries such as India and Indonesia that have reduced exports of key commodities. Added to this is possibly higher transport costs, driven by a substantial increase in the fuel price (+10.7%m/m in June). 

Core CPI inflation (excl food, fuel, and energy), a proxy for second round inflation, increased by 4.1% from 3.9%. The outcome was in line with market expectations. While the annual rate of increase is creeping closer to the midpoint of the target band of 4.5%, the outcome does not yet signal a broad based rise in prices. We estimate that a weaker ZAR's pass-through effect is 0.13 to 0.15ppt over four to five quarters.

However, the concern is that inflation expectations could increase owing to the higher headline CPI inflation print. 

The outcome most likely cements a 50bp increase at the July MPC meeting. The market, however, is concerned about a 75bp rate hike, of which I attach a probability of 30% vs. 70% for a 50bp increase. 

The knock-on effect of headline CPI inflation's higher than expected outcome lifts our 2022 annual average from 6.1% to 6.4%, with a year-end reading of 6.0%. However, the direction of the oil price remains an important driver of where inflation is heading after a peak in 3Q of 7.1%.