Interest rates unchanged
On Tuesday, the SA Reserve Bank left rates on hold amidst uncertainty and sticky inflation expectations – Arthur Kamp, investment economist at Sanlam Investments
Says Arthur Kamp, investment economist at Sanlam Investments, despite domestic real GDP growth advancing well below trend, moderating nominal wage growth per worker, weak household credit extension and an excessively high unemployment rate of 27.1%, the Reserve Bank is still putting rates firmly on hold. Reasons for this include “moderate” upside risk to the inflation outlook, uncertainty around expected changes to US economic policy and concern that “second round” effects on prices could still emerge. The concern over possible second round effects stems from food price inflation (which is still high) and recent marked increases in the Rand price of oil against a backdrop of relatively high and sticky inflation expectations.
Impact of a Trump administration
The Reserve Bank’s Statement also reflects on the uncertainty of the scale of possible economic policy changes in the US under a Donald Trump administration and their potential impact on emerging markets. It should be remembered that the US Federal Reserve is already in an interest rate hiking cycle, which is projected to continue, partly due to expectations that the low US unemployment rate could exert upward pressure on wages and ultimately inflation. Add the possibility of renewed US fiscal policy loosening (although detail remains thin at this point) and there is a real risk that the US Federal Reserve could be more aggressive than we would like in hiking its policy rate. If so, this risks currency depreciation and possible upward pressure on interest rates for emerging market countries like South Africa, which are running macroeconomic imbalances and rely on foreign capital inflows to supplement domestic savings.
Core inflation steady
Most importantly, the Reserve Bank’s inflation forecast has deteriorated and the Bank now expects the annual advance in headline consumer price inflation to return below the 6% upper limit of the Bank’s inflation target range by the final quarter of 2017 only, while inflation is expected to average 6.2% in 2017, significantly higher than the Bank’s previous average forecast of 5.8%. The Bank’s forecast thereafter shows some moderation to 5.5% in 2018, but if the upward shift in its forecast is realised it implies the Monetary Policy Committee is likely to keep the repo rate on for an extended period – or at least until the likely response of the US Federal Reserve to any US fiscal policy loosening, if any, is clearer.
At least, the peak in inflation (6.6% in 4Q16) is probably behind us and core inflation remains steady. The Bank’s forecast for core CPI is also unchanged at 5.5% and 5.2% for 2017 and 2018 respectively. Should the US interest rate hiking cycle remain moderate and should the Rand remain well behaved against this backdrop the hope for a domestic interest rate cut late in 2017 is still alive.
Persistent sub-part economic activity
But, the current outlook for South African GDP and inflation still paints a dismal picture of continued sub-par real economic activity and elevated inflation and inflation expectations. The Bank’s Monetary Policy Committee Statement is very clear that the only way to improve this unfavourable growth is to implement structural economic reforms that lifts business and consumer confidence.
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