Industry commentary on interest rate hike by 50 basis points
South African Reserve Bank Monetary Policy Committee raised the key monetary policy interest rate by 50 basis points. The following commentary has been received.
Old Mutual Wealth comments on interest rate hike
Izak Odendaal, Investment Analyst
Today’s meeting of the South African Reserve Bank’s Monetary Policy Committee (MPC) comes at a time of volatility on global markets. There is also a deep pessimism over South Africa’seconomic prospects and concerns over the direction of economic policy. The 0.5% interest rate hike will probably add to the gloom of the general public. Three MPC members favoured the 0.5% hike while two members favoured a 0.25% hike. There was no real possibility of keeping rates unchanged (though one member did favour it).
Weak rand the main factor
Top of mind for the MPC would have been a weaker rand, since this is precisely what they have warned about for the past two years. Though the rand is off its weakest levels this month, it remains significantly weaker than R14.50 per US dollar at the time of the 19 November MPC meeting (when the MPC hiked the repo rate by 0.25% to 6.25%). The rand has lost 13% since the previous MPC meeting on a trade-weighted basis.
The Reserve Bank’s inflation forecasts have deteriorated markedly. It now expects consumer inflation to average 6.8% in 2016 (6% previously) and 7% in 2017 (5.8% previously). Inflation is expected to peak at 7.8% in quarter four of 2016 and should remain above the upper end of the target range for the entire forecast period. Core inflation is also expected to average 6% in 2016 and the MPC sees this as an indicator of potential second round inflationary pressures, particularly since inflation expectations are rising (especially among trade union representatives) and wage growth remains above inflation.
The pass-through from a weak rand to consumer inflation has been remarkably low until now, but the MPC is concerned that it can increase.
Food inflation likely to rise further
Food is also a concern given the worst drought in decades. South Africa’s Crop Estimates Committee this week said local maize growers would probably produce 7.44-million metric tons in the current season, a slightly better than expected estimate, but still 25% less than the previous season. Maize futures prices have jumped 150% year-on-year, while the latest producer inflation numbers show a 53% annual increase in the ‘cereals and other crops’ category. This has contributed to food inflation at the consumer level rising 5.8% in December. The Bank expects food inflation to rise to 11%.
Fortunately, the oil price has fallen faster than the rand recently. In US dollar terms the price per barrel of Brent crude oil fell from US$45 to around US$30 since the last MPC meeting. Even in rand terms it fell from R600 per barrel to R536 per barrel. This is a major help, but not enough, and the Reserve Bank expects global oil prices to rebound to US$50 per barrel over the next two years.
Growth outlook has worsened
The MPC’s problem is that the domestic growth outlook has weakened further. Real economic growth of only 0.9% in 2016 and 1.6% in 2017 is now expected, compared to the estimates of 1.5% and 2.1% at the time of the previous MPC meeting. The SARB’s estimate of potential growth is only around 1.5%, meaning that the output gap is not as large as might be imagined.
While rates have gone up and are likely to rise further, some perspective is necessary. Even if interest rates are increased by another 1.50% in the current cycle, this would still be the mildest cycle since the 1960s. The repo rate would peak at a level only slightly higher than where the 2003 to 2008 cycle bottomed. The reason for this is that inflation remains relatively low despite the weak rand, food inflation and electricity tariff hikes we’ve had over the past five years. Whether this situation lasts is crucial to economic prospects over the next two or so years. Real interest rates would still remain quite low compared to the post-1994 era. Even after the hike, the repo rate is still below the Bank’s projection of inflation over the next two years so it would not necessarily make cash an attractive asset.
Bank’s repo rate hike is but one step amid broader policy tightening
Arthur Kamp, Investment Economist at Sanlam Investments
Amid waning liquidity, higher funding costs, rand weakness and rising inflation South Africa needs a decisive policy response. The 50bp hike in the Reserve Bank’s repo rate to 6.75% per annum, effective from 29 January 2016, at the conclusion of its Monetary Policy Committee (MPC) meeting on 28 January 2016 is the first step needed to maintain macroeconomic stability.
Waning foreign capital inflows have been insufficient to cover the current account deficit, culminating in a weak rand. Although the feed-through effect from rand weakness into inflation has been modest in recent years, it would be a surprise if the rapid decline in the currency since October 2015 does not cause a marked increase in inflation. History suggests feed-through effects to inflation increase markedly when the currency falls sharply in a short space of time.
The palpably weak state of real economic activity gives pause for thought. However, in addition to the collapse in commodity prices, the root cause of South Africa’s poor GDP growth performance is to be found mainly in weak productivity levels and infrastructure constraints. When an economy’s supply side is not functioning efficiently, there is little the monetary authorities can do to lift growth.
Rather, the task at hand for the Bank is to contain inflation expectations and maintain a relatively stable, low inflation rate (between 3 and 6%) over the medium to long run.
It is therefore no surprise the Reserve Bank has responded to the inflation threat at hand. The Bank argues inflation risks are materialising amid elevated inflation expectations and forecasts an increase in headline consumer price inflation to 7.8% by the final quarter of this year. Thereafter CPI is expected to average 7% in 2017, well above the upper limit of the Bank’s inflation target range.
Looking ahead, the MPC indicates future interest rate decisions will be data dependent, but also observes that the current monetary policy stance remains accommodative, given the expected increase in inflation. Further interest rate hikes seem likely, although the extent of this will depend on the future behaviour of the currency, actual inflation outcomes and inflation expectations.
But, whereas the hike in the Bank’s policy rate is appropriate in the current situation, the main thrust of the policy response to maintain macroeconomic stability should be through changes in fiscal policy. Looking towards the National Budget for 2016 to be read by Minister Gordhan next month, it seems a repeat of the 2015 Medium-Term Budget Policy Statement will not be sufficient. The National Treasury should show a clear, credible path to debt stabilisation as it attempts to stave off further sovereign debt rating downgrades and restore bruised investor confidence.
Tax increases seem likely, but the scope for tax rate hikes or the introduction of new taxes is limited, given the weak state of the economy. Fiscal consolidation should also include trimming of government’s medium-term expenditure projections.
Tightening monetary and fiscal policy can be expected to inflict pain on the economy in 2016, but the alternative appears worse. Foreign savings are needed to fund investment. Should the policy response fall short, South Africa is likely to struggle to fund its current account deficit, which implies economic growth cannot lift. If so, we risk slipping into a prolonged stagflation environment of elevated inflation and low growth.
Finally, the near-term monetary and fiscal policy response is one thing. Looking further down the road South Africa requires material structural economic reform to lift productivity and growth meaningfully.
SARB raises rates by 50 basis points amid weak growth
Sanisha Packirisamy, Economist, and Herman van Papendorp, Head of macro research at MMI Holdings
Reserve Bank wrestles with a sharp deterioration in the inflation outlook against a significantly weaker growth backdrop.
Despite signs of a weakening domestic economy, the South African Reserve Bank (SARB) raised interest rates by 50 basis points in an effort to contain rising prices. A sharp 12.9% depreciation in the trade-weighted currency since the November meeting, drought-inflicted food price shocks and the potential burden of an additional c.17% electricity tariff increase have driven the SARB’s inflation projections considerably higher over the next two years relative to their previous November 2015 forecasts. Following rising inflation risks, the market’s views had shifted since the last Monetary Policy Committee (MPC) meeting, favouring a 50 basis point increase. Heading into the meeting, nineteen out of 31 economists polled by Reuters had forecasted a 50 basis point rise, with only eleven predicting a hike of 25 basis points. According to forward-rate agreements, the money market had been pricing in a 70% chance of a 50 basis point increase in benchmark interest rates.
Grim domestic growth prospects due to fragile global economic activity and decimated local sentiment
Growing pessimism surrounding the state of the SA economy has created a subdued environment for growth in domestic demand. The worst drought in decades has likely further fuelled growth downgrades. Despite agriculture only contributing 2.2% to SA’s GDP, the severity of the drought will have adverse consequences for SA’s exports (agricultural commodities constitute over 10% of SA’s total exports) and will likely force SA to import agricultural products. The Reserve Bank has in response downwardly adjusted their SA GDP growth projections by 0.6% this year as well as by 0.5% in 2017 (see chart 1) and are now expecting a further widening in the current account deficit. Despite the downward adjustment to real GDP expectations, the SARB continues to flag further downside risks to economic growth. On-going electricity supply constraints could continue to hurt growth at least until 2017 when more energy-generation capacity comes online easing SA’s electricity shortages. The downward revision to the SARB’s growth forecasts could have also been a function of lower global growth expectations. The assumptions released by the Bank reveal that their real GDP growth expectation for SA’s main trading partners shifted 0.2% lower to 2.9% in 2016, but remained steady at 3.3% in 2017, when compared to their November 2015 forecasts.
Internally, our views on domestic growth are in line with the SARB’s projections at 0.9% in 2016 and 1.6% in 2017. In our view, heightened investor unease, delays in fixing infrastructure gaps (including energy constraints) and industrial tensions have been behind the SARB’s downgrade to potential growth estimates. The Bank revised potential growth lower to 1.5% in 2016 (previously 1.9%), rising to a muted 1.6% in 2017 (previously 2.1%).
Inflation on the rise
Iran's first shipments of crude oil, since the lifting of sanctions two weeks ago, together with talks of coordinated production cuts among both Opec (Organization of the Petroleum Exporting Countries) and non-Opec members have led to a further rally in oil prices. The MPC have accordingly marked down their forecasts for Brent crude oil to an average of USD41/bbl this year (previously 56), increasing to USD50/bbl in 2017 (previously 60).
A sharp depreciation in the trade-weighted currency and rising food prices have intensified upside risks to the headline inflation profile, but the Reserve Bank suggests that risks to the inflation outlook remains balanced on a lower currency pass-through and a further potential dip in international oil prices. The SARB now sees average headline inflation at 6.8% in 2016 (previously 6.0%, see chart 2), peaking at 7.8% in 4Q16 and 1Q17 (previously 6.9% in 1Q16). Headline inflation is expected to remain outside the target band for the forecasted horizon, whereas previously it was expected to breach for two quarters only. Our internal forecasts are lower than the SARB’s projections for both 2016 (6.4%) and 2017 (6.3%). Relative to the Bank’s forecasts, we are estimating a lower oil price, but a higher electricity tariff increase (16.0% versus 12.2%).
Sticky inflation expectations pose further threats to second-round inflation effects on both the core and headline measures of inflation. Longer-term inflation expectations, as reflected in the Bureau of Economic Research’s survey, have deteriorated over the course of the past year by 0.4% for businesses and 0.2% for labour (see chart 3). Although analysts’ expectations remain anchored at 5.5% in the longer run, the price-setters of the economy see inflation pressures building over the medium to long term. Businesses expect headline measures of inflation to average 6.5% over the next five-year period while labour sees inflation at 6.2%. The extent to which inflation expectations have crept higher above the upper end of the target range raises concerns over additional second-round inflation impacts. Given that this survey was conducted prior to the major currency sell-off in December 2015, it is possible that we could see a further worrying rise in inflation expectations in the next survey.
Currency depreciation and high nominal wage settlements are likely to prevent a significant improvement in core inflation (headline inflation excluding the impact of food, non-alcoholic beverages and energy) this year from the 5.7% print experienced over 2015. Moreover, underlying price pressures face a possible 16.6% electricity tariff increase which Eskom requires to offset R22.8 billion worth in costs.
The Reserve Bank’s core inflation forecasts have deteriorated materially. They now expect core inflation to average 6.0% in 2016 (previously 5.5%) and 5.9% in 2017 (previously 5.4%) as a result of a weaker exchange rate assumption and higher expected unit labour costs (see chart 4). On the contrary, we expect core inflation to average at a lower 5.5% in 2016, retracing further over 2017. Nevertheless, we are of the opinion that in addition to a weaker currency and high nominal wages, inflation expectations which remain entrenched above the upper end of the target range will likely keep core inflation above the mid-point of the target band for some time.
Three members against the 50 basis point increase
The Governor pointed out that the committee’s views were mixed at the interest rate decision meeting. Although three members argued for a 50 basis point rate increase, two members favoured a smaller 25 basis point hike in the repo rate, while one member preferred to keep rates on hold.
Monetary policies continue to diverge between oil-exporting and oil-importing countries
The World Bank in their recent Global Economic Prospects report highlighted the continued divergence between oil-exporting and oil-importing countries. Lower oil prices have allowed a further deceleration in headline inflation allowing for a further easing in monetary policy in oil-importing nations, while currency depreciation pressures have increased inflation and financial stability risks in a number of commodity-exporting nations.
Economic activity weakened across broader Latin America over 2015 on the back of lower commodity prices, a deceleration in growth in major trading partners and persistent domestic challenges. Meanwhile inflation pressures have mounted on higher food prices and currency weakness leaving many of these economies in a familiar stagflation bind. Monetary policy rates have subsequently been raised to curb rising inflation risks amid slowing growth.
SARB maintains hawkish stance
Notwithstanding continued downside risks to a downwardly-revised economic growth forecast, currency and food price risks have materialised, leaving the Bank with an expectation of an extended breach of the inflation target for their forecasted horizon. The MPC noted that downside risks from lower international oil prices and a muted rate of currency pass-through into consumer prices are seen to be largely offset by upside risks posed by a further potential weakening in the currency and a higher rate of pass-through, thereby leaving risks to their inflation trajectory relatively balanced.
Today’s 50 basis point move higher in the benchmark interest rate has likely entrenched the SARB’s credibility. They have shown a firm commitment to their inflation targeting regime by reacting pre-emptively to a rising inflation trajectory. In our view, a higher inflation profile, stubbornly-high inflation expectations and a sizeable current account deficit still point to the need for a further rise in interest rates.
The Bank noted that non-residents have been net sellers of South African bonds and equities since the previous meeting (see chart 6), warning that the financing of the current account deficit will be more challenging in an environment of persistent capital outflows from emerging markets. The MPC expects a widening of the current account deficit from 4.2% of GDP in 2015 to 5.2% in 2016 (previously 4.6%) and 5.3% in 2017 (previously 4.6%).
We expect rates to rise by a further three increments of 25 basis points each over the course of 2016-2017 as the SARB continues to balance rising inflation pressures against further downside risks to economic growth. The pace of additional rate tightening will likely remain a function of how inflation expectations react to the increasing risks of a low growth and high inflation environment.
Inflation could still edge higher than anticipated, despite rate hike
David Crosoer, Head of Research and Investments, PPS Investments
The weak rand has clearly amplified the Monetary Policy Committee’s concern that inflation expectations have increased significantly since their November 2015 meeting, despite economic conditions remaining weak.
Despite the adverse impact a rate hike will have on the economy, the MPC felt it had little option but to raise short term interest rates by 0.5%, given its expectation that inflation would remain outside the 6% upper band for the entire forecast period and peak at 7.8%.
The MPC has now hiked interest rates by a cumulative 1.75% since January 2014. We anticipate that despite the rate hike a number of variables outside their control could still lead to inflation edging higher than they anticipate.
These include further electricity hikes, a potential VAT increase, and an even greater pass effect through from the weak rand.
Attention now shifts to the upcoming budget speech in February where investors will scrutinise the government’s ability to balance its books in this low-growth economic environment where both the MPC and the IMF have now forecasted growth to be below 1% in 2016.
FNB - Rate hike addresses threats to SA economy
First National Bank (FNB) will increase its prime lending rate by 0.50%, taking the rate from 9.75% to 10.25% following the decision announced earlier today by the SARB Monetary Policy Committee (MPC). The new rate is effective on all prime-linked loans from Friday 29 January 2016.
“We should all welcome the bold step taken by the SARB earlier today. While the hike is painful, the severe instability we have experienced in recent weeks had to be addressed as the effects of an unstable currency and rising prices will hurt all consumers,” says FNB CEO Jacques Celliers.
“The rate hike is a firm move to restrain inflation without placing constraints on the economy, but the full effect of the today’s hike will only be felt in coming months and we urge consumers to take a careful review of their budgets as we go into 2016. There may be further rate hikes during the year,” added Mr Celliers.
Says Sizwe Nxedlana, Chief Economist at FNB; “Despite the weak growth backdrop, the Reserve Bank raised rates at the January MPC meeting in line with expectations. With inflation likely to rise over the course of 2016 and to average more than 6% this year, we expect the SARB’s hiking cycle to continue. The upward trend in inflation will be driven by a combination of meaningful drought-induced food price increases, coupled with sharp increases in electricity tariffs.
“A more pronounced currency pass-through poses upside risk to this relatively negative inflation projection.Furthermore, given the deterioration in South Africa’s sovereign credibility we need higher interest rates to entice foreign investors and compensate them for the additional country risk they face. That we are now perceived as a riskier investment destination is reflected in the sharp increase in government borrowing costs since early December. Failure by the SARB to react to this with higher interest rates could threaten even more rand weakness and higher inflation.”
