The South African Reserve Bank opted to increase the Repo rate by 25bps to 6.00% at its MPC meeting . This was in line with market expectations. The Reserve Bank last adjusted interest rates on 18 September 2014, when they increased rates by 25bps. The prime interest rate should now rise 25bps to 9.50%. According to the MPC statement, the decision to hike rates largely reflects upside risks to inflation and the vulnerability of Rand. The decision by the committee was split between 4 members arguing for a 25bps hike and two members suggesting rates should remain unchanged.
For the first time ever, the Reserve Bank included a detailed list of their underlying economic assumptions as well as their key forecasts (see PDF documents attached). In particular, they expect some oil price appreciation in 2016/2017, as well as a modest rise in world food prices, but a subdued commodity price cycle over the next 12 to 18 months. It is concerning that the Reserve Bank’s estimation of potentially growth remains low over the next 2 to 3 three years at around 2.1% to 2.3%.
Summary of the key points from the Reserve Bank’s MPC statement today, most of which focused on the outlook for inflation expectations and the vulnerability of the Rand:
- Domestically, the growth outlook remains weak, as both the supply and demand sides remain constrained amid declining business and consumer confidence.
- The risks to growth are still assessed to be moderately on the downside.
- The recent further decline in the Bank’s composite leading business cycle indicator also suggests a continuation of the weak growth outlook.
- Underlying this subdued growth outlook is the persistent weakness in growth in gross fixed capital formation, particularly by the private sector.
- The inflation forecast has deteriorated slightly since the previous MPC meeting, notwithstanding the lower-than-expected inflation outcome in June.
- Headline inflation is expected to breach the upper end of the target range during the first two quarters of next year.
- The inflation forecast of the Bank has changed marginally since the previous meeting of the MPC, with headline inflation now expected to average 5.0% in 2015, up from 4.9% previously.
- The inflation forecast for the first two quarters of next year has also been revised up by 0.1 percentage point to 6.9% and 6.1% respectively, with a return to within the target range by the third quarter of 2015.
- The headline inflation forecast assumes electricity price increases of 13.0% from July 2016 and July 2017.
- Inflation expectations have shown a near-term deterioration
- The inflation forecast assumes a relatively stable real effective exchange rate over the forecast period. A nominal depreciation in excess of this would pose an upside risk to inflation.
- The rand exchange rate has been relatively volatile and depreciated significantly since the previous meeting of the MPC.
- Global capital flows have remained relatively volatile against the backdrop of changing risk perceptions.
- The rand remains a significant risk factor to the inflation outlook given the vulnerability of the rand and long bond yields to possible US interest rate increases, as well as a deterioration in South Africa’s terms of trade.
- The extent to which US policy tightening is already priced into the exchange rate also remains uncertain.
- The pressures on the exchange rate have been exacerbated by the recent significant decline in commodity prices, which are likely to impede the favourable current account adjustment
In term of the impact on growth of a further rate hike, the MPC highlighted that they are cognisant of the fact that domestic inflation is not driven by demand factors, and the outlook for household consumption expenditure remains subdued. Ultimately the Reserve Bank is concerned that “failure to act against these heightened pressures and risks will cause inflation expectations to become entrenched at higher levels”. It is clear that the Reserve Bank is uncomfortable that any number of factors could push inflation above the target on a persistent basis. This applies especially to further rand weakness, which could be induced by the US hiking rates. While the Reserve Bank acknowledges that the economy remains very weak, their primary mandate is to keep inflation under control. The tone and focus of the latest MPC makes it clear that the Reserve Bank wants to try and ‘normalise’ rates, but probably at a modest pace.
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