PwC focus post interest rate decision
Interest rates steady for now, but economic growth revised downward
SARB keeps interest rates on hold in July after global trade tensions reveal rand vulnerability
The Monetary Policy Committee (MPC) of the South African Reserve Bank (SARB) kept interest rates steady in July, holding the repo rate and prime lending rate at 6.50% and 10%, respectively. This decision reflects the consensus view of economists and echoes the worsening of risk to the inflation outlook since the last MPC meeting in May. Furthermore, the SARB revised down its expectation for economic growth in 2018 to 1.2% from 1.7% previously. Current demand pressures in the economy do not pose a risk to the inflation outlook, according to SARB Governor Lesetja Kganyago.
Inflation likely to have passed cyclical trough
Headline inflation ticked up marginally in June, recording 4.6% year-on-year (y-o-y) from 4.4% y-o-y in the previous month. While food prices have moderated, higher oil prices and the weaker exchange rate drove up transport inflation: inland petrol prices increased by a cumulative R3.17/litre for 93 octane and R3.16/litre for 95 octane compared to July last year, a rise of approximately 25%.
Moreover, Governor Kganyago emphasised the risk of the weaker exchange rate to the inflation outlook. Since the previous meeting of the MPC, the rand depreciated by 7.2% against the US dollar and by 4.9% on a trade-weighted basis. Global trade tensions and developed market monetary policy tightening have contributed to the outflow of capital from emerging markets, including South Africa.
While revising downward the SARB’s expectations for inflation in 2018, from 4.9% to 4.8%, the expected inflation trajectory has risen in the following two years. Inflation could peak at 5.7% in the first two quarters of 2019, likely averaging 5.6% next year and 5.4% in 2020, up from 5.2% in both 2019 and 2020 expected previously.
Downward revision of economic growth, but consumers still optimistic
In view of the slower-than-expected start to the year for the South African economy, the SARB revised downward its expectation for economic growth in 2018 to 1.2%, from 1.7% previously. Based on disappointing first quarter economic growth results and weak initial information about the economy’s performance in the second quarter, the improvements in consumer and business confidence have been slow to translate into higher fixed investment and the much-anticipated upswing in economic growth. Indeed, fixed investment spending retreated 3.2% q-o-q in the first quarter of 2018.
According to the SARB, consumer spending is to remain constrained for the rest of this year, with the effects of the VAT tax hike, weak credit extension growth, numerous fuel price increases, and little movement in employment growth putting a cap on consumer demand. Nonetheless, consumers remain staunchly optimistic. While the FNB/BER consumer confidence index lingered in negative territory throughout last year, consumer confidence rebounded to record heights of 26 index points in quarter one and only retreated 4 index points to 22 in quarter two.
Interest rate hiking cycle: sooner and more severe
While the current monetary policy stance is deemed accommodative by the SARB, the outlook appears increasingly hawkish. The central bank’s internal modelling now incorporates the worsening in the inflation outlook, particularly in 2019 and 2020, and suggests two interest rate hikes of 25 basis points (bps) are possible before the end of 2018. This would entail a 25 bps hike at both the September and November MPC meetings – the last two MPC meetings in 2018.
An increase of 25 or 50 bps by year-end suggests an earlier start to the interest rate hiking cycle than expected as recently as the March meeting of the MPC, which indicated the start of the rate hiking cycle for end-2019 only. Furthermore, the SARB’s Quarterly Projection Model suggests five increases of 25 bps are possible by the end of 2020, while only four increases of 25 bps were indicated in the MPC’s May meeting. Should the key risks to the inflation outlook moderate, especially current exchange rate and fuel price risks, the SARB may decide to keep interest rates on hold for longer, delaying the first interest rate hike to 2019.
