Another tough call for SARB this week, but hike may just be on the cards

• The growth outlook is likely to weigh heavily on the minds of the MPC this week • We are deeply concerned about the damage the current strike is doing to South Africa’s manufacturing attractiveness • Though it would be a very close call, we expect a rate hike of 25 basis points

The economic situation has hardly improved since the South African Reserve Bank’s (SARB) previous monetary policy committee (MPC) meeting. This makes this week’s interest rate decision so much more difficult.

Strike consequences are ‘deeply concerning’

In May, the MPC met amid the longest mining strike in the history of the country, which played a significant part in the GDP contracting by 0.6% in the first quarter of this year. Even though this strike is now resolved, it was quickly followed by a strike in the manufacturing sector, as well as weak mining and manufacturing data.

We are deeply concerned about the impact of the Numsa strike on growth prospects, there are two other very important issues regarding this bout of industrial action that should not be overlooked. Firstly, it is damaging the attractiveness of South Africa as manufacturing destination. There is a significant risk that Numsa is effectively ‘killing’ industries – similar to what Amcu did in the platinum sector – with rationalisation an inevitable consequence. Secondly, the work shutdown at Medupi is severely worrying due to the effect this will have on electricity supply.

Risks to keep rates on hold

In the light of the still weak economic position, it would be easy to use growth concerns again to justify no change in rates. However, there are some risks to this stance.

Primarily, the inflation outlook is cause for concern: inflation for May was worse than the SARB expected and this is likely to be the case for June as well. There is also a case to be made that South Africa should have positive real interest rates when the US eventually starts to raise rates. The question is whether the SARB should gradually move rates higher, or keep rates on hold till the US hikes?

It will be difficult for the SARB to have a hawkish tone and maintain that we’re in a hiking cycle if they keep rates on hold for much longer. At some point they will have to hike, or else the market will stop believing that rates will rise. If the yield curve becomes unhinged to a certain extent and longer-dated bonds start selling off, it will coincide with an outflow from the bond market and a weaker currency – not a good prospect for inflation.

There is also growing encouragement internationally for rates to normalise, as could be seen from the Bank of International Settlements’ recent annual report. The report also noted that monetary policy cannot do the work that structural reforms should do.

Close call, but rates to rise

Therefore, taking all the risks into account, we expect a rate hike of 0.25%, though we do acknowledge that it will be a very difficult decision and voting will probably be a lot closer than in May (when the committee voted by 5-2 to keep rates on hold).