The South African Reserve Bank (SARB) Monetary Policy Committee (MPC) is meeting on 17 and 18 January to deliberate interest rates. Maura Feddersen, economist with PwC’s Strategy&, unpacks what could happen.
The central bank’s monetary policy stance aims to keep inflation in the target range of 3%-6% annually, thereby protecting the value of the currency and the purchasing power of South African consumers. SARB governor Lesetja Kganyago has previously noted the SARB is aiming for headline inflation to settle around 4,5% annually.
All bets were off at the end of last year, as uncertainty over political developments dominated the outlook for the direction of economic policy and the economy at large. The election of Cyril Ramaphosa as party president at the African National Congress (ANC) elective conference was viewed as market friendly, lifting investment confidence and hoisting the rand to R12.30-R12.40/$ in the early weeks of January, from R14.40/$ in November 2017.
Headline consumer inflation declined to 4,6% year-on-year (y-o-y) in November from 4,8% y-o-y in October, slightly better than analysts’ expectations of 4,7% y-o-y. At the last MPC meeting, the SARB estimated inflation to average 5,2% and 5,5% in 2018 and 2019, respectively. Additionally, the central bank’s internal modelling suggested three interest rate hikes of 25 basis points (bps) each were possible — but not guaranteed — by the end of 2019.
Below we outline a list of economic trends we think the MPC will consider this week:
Trends pointing to lower interest rates
* Stronger exchange rate diminishes risk of imported inflation – Following the outcomes of the ANC elective conference, the rand has benefited from global markets flush with liquidity and renewed appetite for emerging market assets. The rand has strengthened approximately 15% against the dollar since November last year. With a stronger rand, imported goods, like fuels and other inputs to production, are cheaper, which limits the risk of imported inflation.
* Low growth to continue – Governor Lesetja Kganyago noted at the MPC’s November meeting that South Africa’s economy was at no risk of overheating from excessive demand pressures, which was reflected in muted core inflation outcomes. The World Bank’s most recent predictions for South Africa estimate GDP growth of only 1.1% in 2018. The SARB said in November it estimates South Africa could achieve growth of 1.2% in 2018, which is still a far cry from the 5%-6% required to make a noticeable dent in persistent unemployment and poverty.
* Food price inflation stable, but meat industry still in drought fallout – As an acute contributor to recent food price inflation, meat prices increased by 15.6% y-o-y in September last year, only slightly moderating in October and November. Bread and cereals price inflation dipped to negative territory in August 2017, helping to return food inflation to within the inflation target in the same month. Even if this season’s maize harvest does not reach last year’s record levels, which depends on rainfall in coming weeks, South Africa remains well supplied in the short to medium term. Meat price inflation, on the other hand, remains high as farmers restock their herds following the fallout from the drought.
* Electricity price increases contained by regulator – South African consumers and businesses breathed a sigh of relief as the National Energy Regulator of South Africa (NERSA) announced in December it had rejected Eskom’s application for a 20% tariff hike, allowing only a 5.2% increase from 1 April 2018. This contains a key source of inflation across the economy.
Trends suggesting stable or higher interest rates
* Oil prices hit highest level since 2014 – Within the first few weeks of the year, WTI crude oil futures rose to $70 a barrel for the first time in three years as global output contracted and demand strengthened. Output cuts led by oil exporting countries under OPEC and Russia have facilitated a price recovery likely to last through to the end of 2018. Higher oil prices generally suggest increases in petrol costs, stoking transport and food price inflation. However, the impact could be limited by the rand’s recent strength.
* Fiscal and sovereign ratings risks – The next two months will see the delivery of the 2018/19 fiscal budget and a review of the sovereign’s creditworthiness by ratings agency Moody’s Investors Service. The National Treasury is facing a large revenue shortfall for the current financial year and has yet to provide details on how it will address a commitment by President Jacob Zuma to phase in free tertiary education from this year. A further ratings downgrade by Moody’s could trigger a significant outflow of capital from the domestic bond market, which would adversely affect the rand.
* Developed market monetary policy tightening – The US Federal Reserve raised the target range for the federal funds rate by 25 bps to 1.25%-1.5% during its December 2017 meeting, as employment and economic activity continued to strengthen. Further increases in US interest rates are likely, as corporate tax relief should provide additional growth momentum. Similarly, the Bank of England embarked on a path of monetary policy tightening in November 2017, raising interest rates for the first time in a decade. In an environment of tighter global monetary policy, emerging markets like South Africa could face capital outflows, weaker investment appetite and sustained currency weakness, potentially prompting the SARB to keep interest rates higher in an effort to attract capital inflows.
Balance of risk?
Domestic inflation pressures have eased in the closing months of 2017, largely on the back of softer food price inflation and a comparatively resilient rand exchange rate. This triggered a 25 bps cut in the repo rate in July, bringing the policy rate to 6,75% and prime interest rate to 10,25%. On the back of heightened uncertainties and risk of further credit rating downgrades, the SARB has since remained conservative, keeping rates unchanged in September and November.
In January, the appreciation of the rand exchange rate following the ANC election outcome and NERSA awarding Eskom only a 5.2% annual electricity tariff increase for 2018 has swayed the outlook for inflation with a renewed chance that an interest rate cut is on the cards in January. Looking further ahead, while the CPI outlook remains benign, the SARB has signaled it may lift interest rates by a cumulative 75 bps in the next two years, with higher oil prices and rand depreciation quoted as key risks for the inflation outlook.