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What to expect from November’s interest rate decision

21 November 2018 Maura Feddersen, Economist at PwC Strategy&

The last Monetary Policy Committee (MPC) meeting of the South African Reserve Bank (SARB) in 2018 is well underway, with policymakers considering the possibility of a rate hike in November against the backdrop of rising inflation expectations. SARB Governor Lesetja Kganyago is expected to announce the MPC decision on Thursday, 22 November.

The SARB last cut interest rates in March 2018, when it lowered the repo and prime lending rates to 6.5% and 10%, respectively. As the prospect of rising inflation in 2019 and 2020 emerged, the SARB has increasingly warned of rising interest rates. At the September MPC meeting, three members of the MPC thus voted in favour of an increase of 25 basis points (bps), while four members voted to keep interest rates stable.

In November, policymakers are unlikely to vote unanimously. With the retirement of MPC member Brian Kahn at the end of September, the panel currently consists of six members, which means a 50/50 split of votes is possible. Analysts view the interest rate decision in November as difficult to call. Of the 21 economists in a Bloomberg survey, 11 forecast the repo rate will be increased by 25 bps to 6.75%, and the rest predict the rate will stay at 6.5%.

As the central bank seeks to steer inflation towards 4.5% (the middle of the target range of 3% -6%), the following are the key factors the MPC will consider in reaching a decision on interest rates this week:

Developed market monetary policy tightening

As monetary policy tightening continues in developed markets, emerging markets like South Africa have kept a close eye on what domestic interest rate changes may be required to ensure they remain attractive for global investors. Higher interest rate differentials relative to key developed market interest rates, including the United States (US) federal funds rate, help support South Africa’s relative investment attractiveness and provide support for the rand exchange rate, ultimately limiting the risk of imported inflation. Higher rates in developed economies narrow this differential.

With a more dovish tone emerging from the last US Federal Reserve policy meeting on 8 November, the rand exchange rate was bolstered against the US dollar. After trading in the range of R14.00/$ to R14.50/$ for the most part of November, the SARB may view the risk of imported inflation to be somewhat less concerning compared to when they met two months ago, especially in view of signals of slower interest rate increases in the US.

Nonetheless, the vulnerability of the rand remains a key concern for the SARB. Investor sentiment can change swiftly in response to domestic developments, including the possibility of a credit rating downgrade, as well as in response to changing sentiment towards emerging market currencies, as the example of Turkey and Argentina showed in August this year.

Risk-off sentiment amid global trade tensions and domestic growth concerns

While global economic growth remains broadly supportive of South African economic performance, some signs of a global growth slowdown have started to emerge. Growing trade tensions between the US and its trading partners contribute to concerns around the sustainability of global trade momentum and foster risk-off investor sentiment that damages emerging market prospects.

South Africa’s economic performance remains constrained after the economy entered a technical recession in the first half of the year. Furthermore, low employment growth, tax rate increases and record-high fuel prices have contributed to highly constrained consumer finances. According to the National Credit Regulator (NCR), four of 10 credit active consumers are in poor standing, with accounts three or more months in arrears. Furthermore, household consumption expenditure growth contracted for the first time in two years during the second quarter of 2018. However, retailers’ sales promotions as part of Black Friday may bolster consumer spending in the last quarter of the year.

While South Africa is expected to emerge from the technical recession in the third quarter of this year, the rebound is likely to be subdued. In the Medium Term Budget Policy Statement (MTBPS) delivered by Finance Minister Tito Mboweni in late October, the National Treasury revised down expectations of economic growth to 0.7% in 2018, from 1.5% previously. National Treasury expects economic growth to pick up to 1.8% and 2.1% in 2019 and 2020, respectively.

In view of weak domestic economic growth, members of the MPC would be cautious to raise interest rates in November, unless higher inflation expectations mean a tighter monetary policy stance is unavoidable.

Inflation projections suggest little room to manoeuvre

The SARB’s measure of core inflation, which excludes food, fuel and electricity, remained stable at just above 4.2% in the third quarter, while headline inflation averaged just under 5%, reflecting the impact of higher fuel and utilities prices.

In September, the SARB noted that inflation is expected to accelerate to levels close to the MPC’s upper end of the target range. While expected to average 4.8% in 2018, headline inflation will likely increase to 5.7% in 2019 and moderate to 5.4% in 2020. Headline inflation is projected to peak at 5.9% in the second quarter of 2019. These expectations suggest the SARB has little room to keep rates on hold for much longer: if any upward risks to the inflation outlook materialise, inflation could easily exceed the upper limit of the target band.

Furthermore, changes in interest rates will require a sufficient time horizon for the required inflation limiting impacts to manifest. With inflation peaking in the second quarter of next year, the MPC faces a closing time window to increase interest rates as a way to keep inflation inside the target band. Indeed, the MPC’s decision will likely hinge on the SARB’s expectations for movements in the rand exchange rate and fuel prices.

The balance of risk

The decision whether to embark on a hiking cycle in November, or delay to 2019, will likely be contentious among MPC members, with a unanimous decision unlikely. However, with the price of Brent crude oil futures retreating 18% since the September MPC meeting, the rand strengthening over 2% against the US dollar, and a more dovish tone from US monetary policy makers, the SARB may once again delay the start of its tightening cycle. Nonetheless, the SARB’s scope to keep interest rates on hold is quickly diminishing, especially in the face of growing emerging markets volatility.

Looking further ahead, the MPC’s September statement noted the SARB’s Quarterly Projection Model, which serves as a broad policy guide and not a hard rule, suggests five increases of 25 bps by the end of 2020. However, shifts in the inflation outlook since the September MPC meeting can prompt a revised view in November, as well as further details as to the expected timing of these interest rate increases.

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