Members of the Monetary Policy Committee (MPC) of the South African Reserve Bank (SARB) meet from 15 to 17 January to decide a suitable interest rate stance that sees inflation settle in the middle of the 3% – 6% target range.
The 25 basis points (bps) increase in November last year brought the repo rate and prime lending rates to 6.75% and 10.25%, respectively. As the first increase since March 2016, the SARB signalled the beginning of an interest rate hiking cycle that could entail another three increases of 25 bps before end-2020.
The decision to embark on a hiking cycle in November, rather than to delay, was a close call – as expected. Three MPC members favoured a rate hike of 25 bps while three members would have preferred rates to remain on hold. Mixed views among the policymakers reflect an ongoing dilemma: weak economic performance provides little demand-side price pressure, but supply-side pressures consistently push inflation away from the 4.5% target.
According to SARB Governor Lesetja Kganyago, keeping interest rates on hold in November and waiting for inflation developments to unfold in 2019 would have raised the risk of more aggressive interest rate hiking in coming months. The SARB’s inflation expectations reflect the effect of the interest rate hike in November 2018 and three further increases of 25 bps before the end of 2020, which will bring the repo rate to 7.5%. Based on this interest rate path, the MPC marginally revised down its forecast for headline inflation to 5.5% and 5.4% in 2019 and 2020, respectively. The expected peak in headline inflation moved out to the third quarter of 2019 to 5.6% – previously forecast at 5.9% in the second quarter of 2019.
While the Quarterly Projection Model (QPM), which serves as a policy guideline for the MPC, suggests three further interest rate hikes by the end of 2020, we believe the SARB is unlikely to raise interest rates in January.
Here are the top three reasons why the central bank may keep rates stable in its first MPC meeting of 2019:
Global economy fears dampen oil prices and offer petrol price reprieve
On the back of fears about a global slowdown and continuing trade tensions between the United States (US) and China, oil prices retreated for much of the fourth quarter of 2018. Additionally, record US crude oil production and reports of a sharp increase in US product inventories contribute to a weak outlook for oil prices leading into 2019.
Lower oil prices offered South Africans a welcome reprieve, with the price of inland 95 ULP declining by over R3/litre – from R17.08 to R14.01 between November 2018 and the start of 2019. Similarly, diesel prices are now almost 20% lower than their peak in November 2018.
Figure 1: Petrol prices, inland, 95 ULP and Diesel 0.05%
Source: South African Petroleum Industry Association (SAPIA)
In early 2019, oil prices benefited from hopes that talks in Beijing can address trade tensions between the US and China, while supply cuts by major producers supported prices, however, the longer-term outlook for oil prices has weakened.
Figure 2: Brent crude prices, $ per barrel, monthly average
As a result, the SARB may revise down its expectations of Brent crude prices in 2019 and 2020, after upward adjusting price expectations from $70 to $73 per barrel at the last MPC meeting in November. Consequently, the outlook for inflation may benefit from reduced supply-side pressures.
US equities jitters may slow down pace of US Fed monetary policy tightening
Developed market (DM) monetary policy tightening reduces levels of global liquidity and raises the returns on capital invested in DMs.
Emerging market (EM) central banks therefore keep an eye on the pace of monetary policy tightening in DMs: higher interest rates in EMs become necessary to remain attractive for international investors who weigh the relative risk/return ratios across competing markets. By raising interest rates in EMs, central banks can help ensure attractive investment returns and sufficient capital inflows to finance domestic investment spending, current account deficits, thereby maintaining the value of the currency and mitigating the risk of imported inflation.
While the US has embarked on a path of monetary policy tightening, including hiking interest rates nine times in the last three years by a cumulative 2.25%, a 9.3% decline in the S&P 500 stock market index in December 2018 triggered speculation that the US Federal Reserve may slow down the pace of further monetary policy tightening in 2019.
Figure 3: MSCI emerging markets relative to S&P 500 performance
With US equities disappointing towards end-2018, investors may seek improved returns in EMs in 2019. EM currencies (including the rand exchange rate) may benefit from pro-EM sentiment. However, EM volatility may return as the experiences of Turkey, Argentina and Indonesia and showed in the third quarter of 2018.
Figure 4: Monthly USD/ZAR exchange rate with linear trend line, monthly average
After continuing on a trend of depreciation for most of 2018, the rand exchange rate is potentially undervalued, according to the SARB’s November MPC statement. With the exchange rate breaking R14/$ to the dollar early this month, the immediate risk of imported inflation is limited.
- Economy remains at a cross roads in 2019 – demand pressures weak
The economic growth recovery in the third quarter of last year allowed South Africa to exit a technical recession (two consecutive quarters of negative growth seen in the first half of 2018). Last year’s economic growth results were disappointing, in spite of some recovery in consumer and business confidence. While the SARB predicted annual growth of 1.4% at the start of 2018, by November, this expectation was revised down to 0.6%.
Figure 5: South African economic growth performance and forecast
Source: Statistics South Africa (StatsSA), e – estimated, f – forecast, SARB MPC November 2018
South Africa’s economy is expected to bounce back somewhat in 2019 and 2020, faciliated by an anticipated cyclical upswing and improvements in economic sentiment helped by recent initiatives like the economic stimulus plan, jobs summit and investment summit. However, the possibility of fiscal slippage and a lack of structural reforms can weigh on longer-term economic prospects. Furthermore, renewed concerns around electricity supply and Eskom’s going concern raise the risks to growth, inflation, fiscal outcomes and credit ratings in 2019.
Poor economic growth outcomes and indications of a tentative recovery in 2019 and 2020 are likely to prevent the SARB from raising interest rates in January, especially in the absence of additional supply-side pressures that could cause inflation to move closer to the upper end of the target range.
Interest rate expectations for 2019
The SARB’s interest rate hike in November 2018 affirms the emphasis not only on anchoring inflation inside the target band, but more closely to the middle of the range to allow greater flexibility around the anchor of 4.5%.
Recent improvements to the inflation outlook amid poor economic prospects should result in an unchanged monetary policy stance in January, but also at the MPC’s next meeting in March. Indeed, the SARB may also announce a slight moderation this week in the anticipated pace of monetary policy tightening in 2019 and 2020.
Nonetheless, an increase of 25 bps remains on the cards in the short term if risks to the inflation outlook materialise. These include above-inflation domestic wage growth as well as rising electricity and water tariffs. Furthermore, rand vulnerability poses on ongoing risk to the inflation outlook, which may be stoked by 1) EM risk-spill over, 2) domestic economic policy uncertainty, 3) electricity supply concerns and 4) fiscal slippage.