Yesterday’s meeting of the South African Reserve Bank’s Monetary Policy Committee (MPC) came at a time of volatility on global markets, together with a deep pessimism over South Africa’s economic prospects and concerns over the direction of economic policy.
According to Old Mutual Wealth investment analyst Izak Odendaal, the 0,5% interest rate hike will probably add to the gloom of the general public.
He believes that top of mind for the MPC would have been a weaker rand, since this is precisely what they have warned about for the past two years. Though the rand is off its weakest levels this month, it remains significantly weaker than R14.50 per US dollar at the time of the 19 November MPC meeting (when the MPC hiked the repo rate by 0,25% to 6,25%). The rand has lost 13% since the previous MPC meeting on a trade-weighted basis.
“The Reserve Bank’s inflation forecasts have deteriorated markedly,” Odendaal comments. “It now expects consumer inflation to average 6.8% in 2016 (6% previously) and 7% in 2017 (5,8% previously). Inflation is expected to peak at 7,8% in quarter four of 2016 and should remain above the upper end of the target range for the entire forecast period. Core inflation is also expected to average 6% in 2016 and the MPC sees this as an indicator of potential second round inflationary pressures, particularly since inflation expectations are rising (especially among trade union representatives) and wage growth remains above inflation.
“The pass-through from a weak rand to consumer inflation has been remarkably low until now, but the MPC is concerned that it can increase.:
Odendaal points out that food is also a concern given the worst drought in decades. South Africa’s Crop Estimates Committee this week said local maize growers would probably produce 7,44-million metric tons in the current season, a slightly better than expected estimate, but still 25% less than the previous season. Maize futures prices have jumped 150% year-on-year, while the latest producer inflation numbers show a 53% annual increase in the ‘cereals and other crops’ category. This has contributed to food inflation at the consumer level rising 5,8% in December. The Bank expects food inflation to rise to 11%.
“Fortunately, the oil price has fallen faster than the rand recently,” according to Odendaal. “In US dollar terms the price per barrel of Brent crude oil fell from US$45 to around US$30 since the last MPC meeting. Even in rand terms it fell from R600 per barrel to R536 per barrel. This is a major help, but not enough, and the Reserve Bank expects global oil prices to rebound to US$50 per barrel over the next two years.”
The MPC’s problem is that the domestic growth outlook has weakened further, Odendaal points out. Real economic growth of only 0,9% in 2016 and 1,6% in 2017 is now expected, compared to the estimates of 1,5% and 2,1% at the time of the previous MPC meeting. The SARB’s estimate of potential growth is only around 1,5%, meaning that the output gap is not as large as might be imagined.
“While rates have gone up and are likely to rise further, some perspective is necessary,” Odendaal believes. “Even if interest rates are increased by another 1,5% in the current cycle, this would still be the mildest cycle since the 1960s. The repo rate would peak at a level only slightly higher than where the 2003 to 2008 cycle bottomed. The reason for this is that inflation remains relatively low despite the weak rand, food inflation and electricity tariff hikes we’ve had over the past five years.
“Whether this situation lasts is crucial to economic prospects over the next two or so years. Real interest rates would still remain quite low compared to the post-1994 era. Even after the hike, the repo rate is still below the Bank’s projection of inflation over the next two years so it would not necessarily make cash an attractive asset.”