Interest rate cut on the cards?
Results on the latest MPC meeting on 30 March, by Arthur Kamp, economist at Sanlam Investments
Although the South African Reserve Bank left its repo rate unchanged at 7.00% at the conclusion of its Monetary Policy Committee (MPC) meeting on 30 March 2017, it signalled that the peak of its interest rate hiking cycle had probably been reached. The key development is the Bank’s inflation forecast, which has been lowered to reflect a decline in the annual advance in headline CPI to 5.6% by Q4 2017, from 6.3% in February 2017, followed by an average of 5.4% in 2018. Importantly, core inflation is expected to average just 5.4% and 5.2% in 2017 and 2018 respectively.
Currency stability remains a caveat
There are caveats – particularly currency stability. The rand has appreciated by around 22% since the end of 2015 on a trade-weighted basis, in part reflecting the reversal of previous negative real shocks to the currency, as South Africa’s terms of trade improved in the latter half of 2016, while labour productivity growth returned to positive territory.
The appreciation of the rand should act as a powerful disinflationary force in 2017, despite the recent sell-off in the currency. That said, additional sustained rand weakness could alter this favourable picture. The improvement in South Africa’s current account deficit from -3.8% of GDP in Q3 2016 to -1.7% of GDP in Q4 2016 theoretically reduces the country’s vulnerability to volatile capital flows, but it does not eliminate it. Upside surprises to the expected US interest rate hiking path is one risk. But it is clear that as regards the currency’s near term prospects, the main concern of the MPC is current political uncertainty.
At least, the MPC indicates there are also downside risks to the inflation forecast, if this year’s electricity price increase is lower than expected and if oil prices do not reverse recent declines. Moreover, even though the MPC remains concerned about relatively sticky inflation expectations, which remain not too far from the upper limit of the Bank’s 3% to 6% inflation target, inflation expectations should decline once the downturn in inflation is more entrenched.
A cut is possible by late 2017
Together, the forecast significant slowdown in headline inflation and the improved current account balance against the backdrop of tepid real economic growth only should bolster expectations for an interest rate cut by late 2017. Currently, an interest rate cut of, say, 25bp looks plausible with one more to follow in 2018 – on condition that the expected inflation trajectory pans out. In part, this relies on currency stability, which in turn assumes at the very least that policy certainty prevails. In particular, a sound fiscal policy, which pursues a fiscal consolidation path in line with the numbers outlined in the National Treasury’s February 2017 National Budget, is a key anchor for inflation expectations and the interest rate outlook.
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