Cape Town - Headline inflation of 6.5% is forecast for March - down from 7% in February, emerging markets economist Peter Attard Montalto of Nomura said on Friday.
It is important, in his view, that any interest rate hikes within the SA Reserve Bank's current Monetary Policy Committee (MPC) framework limit behavioural effects, which can increase foreign exchange pass-through and with it contain expectations and prevent wage inflation spirals.
Montalto explained that, despite increasing underlying inflationary pressures, base effects are winning out in the short run.
"We see core inflation stable in March at 5.7%. This is a higher survey month with housing particularly providing two-way risk, while food price risks and general core risks are to the upside."
He regards the drought as the biggest factor impacting the shifting underlying inflation picture. Other factors are forex pass-through, slowly recovering unit labour costs, higher energy prices and a slightly bigger, but still very small output gap.
The so-called underlying "other factors" show since end-2014 that while underlying inflation is high at around 5%, it has fallen back to around 4%, Montalto explained. This is as a result of the slightly large output gap and the impact of lower cost-push pressures from contained real unit labour costs in 2015 in the retail sector - and economy more generally.
"We see these unit labour costs starting to rise, along with expectations, in response to high headline inflation and a recovery in growth - although very slowly and to very low levels," he explained. "This ex-forex core inflation measure should move back from 4.0% to 5.0% in the coming year."
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Nomura's latest inflation analysis showed a lower and flatter exchange rate pass-through curve for the 12 months between 2014 and 2015
"But now it has steepened and is actually showing faster pass-through than our original estimates. This shows some turnaround in the last six months as the rand has weakened," said Montalto.
"Overall, we think we can continue to say that pass-through has bottomed out since the fourth quarter of last year and has most likely risen."
Nomura has found broadly over time around 75% of price contributions to core inflation is forex related.
As for food prices, Nomura's forecast is for a large spike higher in staple foods - such as grains and vegetables - giving way several months later to a peak in non-staples such as meat and processed food prices.
It foresees that these would then have a much slower turnaround as they have longer pass-through cycles and are also more affected by higher sticky raw prices next year from the next harvest that is been under planted.
This factor is key to Nomura's much higher inflation projection for next year compared to that of Sarb and the market.