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SARB expected to remain in rate-cutting cycle

21 September 2017Johann Els, Old Mutual Investment Group
Johann Els, Senior Economist at Old Mutual Investment Group.

Johann Els, Senior Economist at Old Mutual Investment Group.

Weak economic growth, heightened political uncertainty and a potential fiscal fallout will make for a very cautious South African Reserve Bank (SARB) monetary policy decision on Thursday.

Notwithstanding these risks, Johann Els, Senior Economist at Old Mutual Investment Group, believes that the South African Reserve Bank (SARB) will remain in a mild interest rate-cutting cycle. “As is the consensus market view, we expect the SARB to cut the repo rate again this week by 25 basis points, bringing it down to 6.5%. We then expect a further two 25 basis points cuts to occur in this cycle which implies a total of 100bps for this cycle.”

The Monetary Policy Committee (MPC) is also likely to lower their own inflation forecast further, says Els. “We expect CPI inflation to end 2017 at 4.5%, possibly even drifting slightly lower into early 2018. Inflation is expected to move largely sideways through 2018 to end the year at 4.7%, thus, from an average inflation of 6.8% in 2016, to an expected 5.3% in 2017 and 4.7% in 2018.”

Regarding GDP growth, Els says SARB will look through the rebound figures of the second quarter, as underlying growth is still week. “First half GDP growth was heavily distorted by the negative growth in the first quarter (-0.6%) and sharp rebound in the second (+2.5%).

“While the economy remains in a slow growth trap, especially compared to the performance in the rest of the world, we anticipate a mild improvement from 2016, when growth totalled 0.3%, and expect 0.8% growth this year.”

Els adds that uncertainty surrounding the country’s pending investment grade decision and the upcoming ANC Elective Conference in December is holding economic growth back this year. “While SARB have little immediate impact on growth through its rate decision, a rate cut can assist in lifting confidence slightly.”

Old Mutual Edge28 Fund Co-Manager, Arthur Karas, at Old Mutual Investment Group, says that with the Rand relatively strong, inflation heading lower and the economy in virtual stasis, he agrees the South African economy quite clearly needs a boost.

Echoing Els’ comments, Karas expects the rate cut cycle to continue, and has positioned the Fund for rate cuts for some time, with increased holdings in SA bonds, SA listed property, SA banks and credit sensitive retailers while reducing cash exposure.

He however adds that high interest rates is not the main concern for markets, but rather one of confidence.

“Any investment decision with a long-term investment horizon becomes challenging when focused on a potentially binary political outcome. Our discussions with domestic banks confirm that both large corporates, smaller businesses and individuals are all behaving in a similar fashion, curtailing new capital investment, hoarding cash or investing off-shore,” explains Karas.

Such an environment is not encouraging for future profit growth, he says. “Combined with other dubious policies, such a mining charter that is very discouraging of new mining investment, it’s hardly surprising that foreigners have been selling South African shares.”

By contrast to the equity market, Karas says that SA bond market has seen steady inflows. “Yield hungry global investors seek to exploit the large spread between SA bonds and sovereign yields available elsewhere. These investors must believe that our political and economic woes are sufficiently discounted into our 8.5% yields. South Africa's attraction or lack thereof, as a portfolio investment destination needs to be compared to yields and returns available elsewhere especially in other emerging markets. Russia, Brazil, Turkey have also seen considerable political turmoil, making South Africa seem less of an outlier from its peers.”

Els concludes, “Similar to GDP growth, a rate cut on its own won’t impact markets, but it will certainly help in supporting both consumer and business confidence – something the South African economy is quite clearly in need of.

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