The South African Reserve Bank’s (SARB’s) last Monetary Policy Committee (MPC) meeting for this year is under way, with SARB governor Lesetja Kganyago expected to announce the outcome on Thursday.
Policymakers are considering the possibility of a rate hike in November, against the backdrop of rising inflation expectations.
The SARB last cut interest rates in March, 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, says professional services firm PwC.
At the September MPC meeting, three members of the committee voted in favour of an increase of 25 basis points, while four members voted to keep interest rates stable.
PwC says policymakers are unlikely to vote unanimously in the November MPC meeting. With the retirement of MPC member Brian Kahn effective end-September, the panel currently comprises six members – meaning a 50:50 split of votes is possible.
PwC says the interest rate decision in November is difficult to call.
Of 21 economists surveyed by Bloomberg, 11 forecast the repo rate to increase by 25 basis points to 6.75%, while the balance expected the repo rate to stay at 6.5%.
As SARB seeks to steer inflation towards 4.5%, which is the middle of the target range of 3% to 6%, PwC notes key factors in considering the final decision.
As monetary policy tightening continues in developed markets, emerging markets such as 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 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 November 8, the rand exchange rate was bolstered against the dollar. After trading in the range of R14 to R14.50 to the dollar 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, says PwC.
Further, 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.
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, says PwC.
According to the National Credit Regulator, four out of ten credit active consumers are in poor standing, with accounts three or more months in arrears.
Further, household consumption expenditure growth contracted for the first time in two years during the second quarter of the year.
However, retailers’ sales promotions as part of Black Friday may bolster consumer spending in the last quarter of the year, the firm points out.
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, it adds.
In the Medium Term Budget Policy Statement delivered by Finance Minister Tito Mboweni in October, the National Treasury revised down expectations of economic growth to 0.7% in 2018, from 1.5% previously.
The 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 of raising interest rates in November, unless higher inflation expectations mean a tighter monetary policy stance is unavoidable, says PwC.
NO MANOEUVERING ROOM
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% this year, 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, says PwC.
Further, 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, it adds.
The MPC’s decision will likely hinge on the SARB’s expectations for movements in the rand exchange rate and fuel prices.
The decision on 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, PwC notes.
However, with the price of Brent crude oil futures having retreated 18% since the September MPC meeting, the rand having strengthened over 2% against the dollar, and a more dovish tone from US monetary policy makers, the SARB may once again delay the start of its tightening cycle, the firm adds.
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 basis points by the end of 2020.