South Africa:SARB on hold as inflation risks are carefully balanced

The SARB unanimously decided to keep interest rates unchanged at 7% today.

    The statement was neutral with carefully balanced arguments supporting and negating inflation pressures. Inflation risks have reduced on account of recent developments, mainly rand appreciation. Despite positive revisions, inflation is still breaching the target for an “extended” period of four quarters - no longer the case for core inflation (only one quarter above 6% - Figures 1 and 2). In conclusion, the Bank stated that it remains data dependent but will react to any “significant change in the inflation outlook”. On balance, we remain comfortable with our view of no further rate hikes, and still see opportunity for a rate cut in 2H17.

    Positive inflation surprises helped by lower fuel prices and stronger rand…

    The SARB made positive revisions to inflation and further cuts to GDP growth - including potential growth (Figure 3). Its quarterly headline figures are between 0.2% to 0.4% lower than before, settling at 6.6% (was 6.7%) and 6.0% (was 6.2%) in 2016 and 2017 respectively. In spite of somewhat higher oil and food inflation assumptions, these changes were mainly driven by the stronger rand exchange rate, which will significantly reduce fuel prices next month. For similar reasons we have taken the knife to our own forecasts, including food inflation assumptions. We now see headline at 6.4% and 5.8% for 2016 and 2017, respectively. This flows from the decision to temper second round effects in our model - thanks partly to a stronger rand exchange rate and somewhat lower than expected oil prices. We see core inflation at 5.8% and 5.5%, vs the Bank’s conservative forecast of 5.7% (unchanged) in 2017.

    Several positive risks to the inflation outlook:

    The Bank has faded the recent positive surprises in core inflation over the next four quarters, but it has also added some fat to the outer years supposedly as pass-through effects are delayed or staggered. The statement also outlines risks to this view. Firstly, much weaker demand could pose more downside risks. Secondly, the 12.5% appreciation in the exchange rate since the last MPC meeting is stronger than the Bank’s current model assumptions.

    SARB is justifiably concerned over the durability of current positive factors...

    The exchange rate remains an upside risk to the outlook, but this depends on global risk appetite and medium-term implications from Brexit scenarios. Importantly, the Bank also holds the view that the search for yield may continue given weaker global growth and negative rates in key developed markets. However, the change in the Federal Reserve Bank’s Policy and other global risk perceptions need to be monitored as potential swing factors.

    Still far from cuts, but there are a few hopeful signals.

    Since there is significant uncertainty over the medium-term prognosis for the global economy and global rates, the Bank has not reduced its 2018 inflation forecasts, which in fact were revised moderately higher by 0.1% (5.5%). Until such time that the Bank sees inflation back at mid-point levels, or below, rate cuts will be unlikely, in our view. Rate cuts have not been discussed this time, but the Governor has made it clear that the MPC remains data dependent. Favourable weather patterns (as predicted by climate specialists) could result in a “sharp decline in agriculture prices next year”. In addition, the absence of demand pressures “may also contribute to downside risks”.