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What to expect from July’s interest rate decision

17 July 2018Maura Feddersen, PwC
Maura Feddersen, Economist at PwC.

Maura Feddersen, Economist at PwC.

The risks to the inflation outlook may have shifted further to the upside since the last Monetary Policy Committee (MPC) meeting of the South African Reserve Bank (SARB) in May. The vulnerability of the rand exchange rate and lower-than-expected economic growth are likely to be key themes as the MPC convenes on 17 to 19 July to deliberate a suitable interest rate stance to keep inflation inside of the target range of 3%-6% annually.

Interest rates to remain stable amid currency and fuel price risks

Global trade tensions and developed market monetary policy tightening have contributed to the outflow of capital from emerging markets, including South Africa. On a trade-weighted basis, the rand depreciated by 4.6%, while also weakening 6.9% against the US dollar since the last MPC meeting.

Source: SARB

A weaker exchange rate poses a key risk to the local inflation outlook, as it drives up the prices of South Africa’s imports. Fuel prices are particularly vulnerable, with imports of mineral fuels including oil constituting the highest value product group in South Africa’s import basket. Consumers currently see the impacts at the petrol pumps, where a combination of the weaker exchange rate and higher oil prices have driven up inland fuel prices by a cumulative R3.17/litre for 93 octane and R3.16/litre for 95 octane compared to last year. Diesel prices increased R3.48/litre, reaching R14.45/litre according to South African Petroleum Industry Association (SAPIA).

This not only stokes transport inflation, but also spurs food prices – an outcome that most affects the poor. As a result, South Africa’s government asked food producers, retailers and transporters to absorb the latest round of fuel price increases. Furthermore, the National Treasury’s VAT panel is currently reviewing which additional items could be added to the VAT exemption list.

The weaker exchange rate not only poses a risk for imported inflation, but also suggests a greater risk of early monetary policy tightening. At the previous MPC statement, SARB Governor Lesetja Kganyago suggested the renewed risks to the inflation outlook could prompt an interest rate hike of 25 basis points (bps) by the end of 2018 already, previously expected for end-2019 only. The prospect of an earlier tightening in monetary policy reflects the changes in risks to the inflation outlook since the March meeting and could be confirmed this week.

SARB could revise downward its expectations for growth in 2018

With a slower-than-expected start to the year, the South African economy is struggling to ramp up to the levels of growth expected by the SARB for 2018. In the first quarter, South Africa’s economy expanded by only 0.8% year-on-year (y-o-y) due to a GDP contraction of 2.2% quarter-on-quarter (q-o-q). To achieve the SARB’s economic growth expectations of 1.7% annually, the economy would have to advance on average by 2.0% in the final three quarters of the year. Initial information about the economy’s performance in the second quarter suggests that recent improvements in consumer and business confidence are slow to translate into higher fixed investment and the much-anticipated upswing in economic growth.

Consumer spending is to remain constrained for the remainder of this year, with the effects of the VAT tax hike, numerous fuel price increases and little movement in employment growth putting a cap on consumer demand. Weak demand and policy uncertainty help to explain the decline in fixed investment in the first quarter of this year, which retreated 3.2% q-o-q. Last week’s announcement of a USD10 billion investment by Saudi Arabia in South Africa’s renewable energies sector therefore comes at a crucial time and could signal a turnaround in recent fixed investment spending trends.

Sombre tone likely at MPC meeting

Headline inflation looks to have settled comfortably inside of the SARB’s target range, recording 4.4% y-o-y in May, down from 4.5% y-o-y in April. Looking ahead, the SARB expects inflation to average 4.9% in 2018 and 5.2% in both 2019 and 2020. The moderation in consumer price inflation provides some relief for consumers, who benefit from greater purchasing power in an otherwise difficult economic environment.

However, the combination of global trade tensions, stronger oil prices and tighter global monetary conditions reveals emerging market currency weaknesses, including those of the rand exchange rate. The SARB will keep its guard up this month and is unlikely to take the weak growth performance as a sign that low demand pressures on inflation will keep inflation under control in the medium- to long-run.

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