The central bank’s Monetary Policy Committee (MPC) will meet on 19-21 July to determine a suitable monetary policy stance that keeps prices stable and provides a sound foundation for sustainable economic growth.
In view of a firmer rand, weaker price pressures and a decline in private sector credit growth in May, the MPC may decide against a further rate hike, although upside risks to the inflation outlook remain.
Economic trends that may see an increase in the policy interest rate
In the MPC’s May 2016 statement, Governor of the South African Reserve Bank (SARB), Lesetja Kganyago, noted that the Committee remained concerned about the inflation outlook and an extended breach of the inflation target.
According to SARB forecasts, headline inflation is only projected to return to the target range of 3-6 percent in the third quarter of 2017.
Although the Reserve Bank is mindful of the effect of interest rate hikes on economic growth, Daniel Mminele, Deputy Governor of the Reserve Bank, recently reaffirmed that the Bank will act if inflation and its outlook remain elevated.
Having increased by 75 basis points to 7 percent since the start of 2016, a number of upside risks may motivate the Bank to raise the repo rate a third time this year:
Oil prices remain volatile
The United States Energy Information Administration (EIA) suggests that international oil prices may be on a slight upward trajectory, with a firmer price increasingly feasible. However, in view of somewhat muted global demand, increased output by OPEC members and surprising crude oil inventories, prices may remain comparatively stable.
The EIA recently increased its forecasts of 2016 average crude oil prices to USD44 per barrel, up from an estimate of USD34 per barrel in April. However, the EIA highlights continued concerns around uncertainty and volatility in the oil market.
Higher than expected oil prices may prompt the SARB to counterbalance increased imported inflation through a less accommodative monetary stance.
Food prices fuelled by drought
Following one of the worst droughts South Africa has seen to date, the impact on food prices is increasingly felt by South African consumers. In May, food prices increased 11 percent year-on-year, with bread and cereals, a key upward price driver, increasing 15 percent in the same period.
During the same month, grain mill production costs increased 21.1 percent year-on-year, suggesting further upward pressure on retail prices during the second half of 2016. While this steeply upward trend has softened recently, food prices remain a key upward risk to the Reserve Bank’s inflation outlook.
Above inflation increases in wages on the cards
Wage negotiations in various sectors are underway, including in the mining and automotive sectors.
Unions are opening negotiations with demands for double-digit increases of between 15 percent and 20 percent, outstripping the Reserve Bank’s May inflation projections of 6.7 percent and 6.2 percent for 2016 and 2017 respectively.
Depending on the outcomes of wage negotiations, the Reserve Bank may need to take account of rising wage-push inflation.
Economic trends to suggest the MPC may want to keep interest rates steady
Muted growth outlook
Although retail sales were unexpectedly buoyant in May, increasing 4.5 percent year-on-year, consumer confidence remains low, influenced by high unemployment and household indebtedness.
McKinsey’s recent survey of 1 000 South African consumers showed that 51 percent of them were finding it harder to make ends meet now than 12 months ago, relative to a global average of 28 percent.
Consumers are increasingly under pressure and South Africa’s consumption-powered growth engine is slowing, with recent annual growth forecasts of 0.6 percent and 0.1 percent projected by the SARB and IMF respectively.
However, Governor Kganyago recently noted that while growth is weak, a turn-around and slow upward trend is expected for the South African economy in 2016.
Firmer exchange rate
Although the rand exchange rate remains highly sensitive to domestic and international developments, the South African currency has strengthened by nearly 10 percent against the US dollar since the MPC’s May repo rate decision.
This is influenced by the US holding off on interest rate increases and the decision by credit rating agencies to grant South Africa a reprieve and keep its investment-grade sovereign rating unchanged.
The performance of the rand has also been supported by increased investor risk appetite and signals of an economic turnaround in the retail and manufacturing sectors. Indeed, the rand has demonstrated resilience in spite of the Brexit shock. Reduced import price pressures may encourage the MPC to keep interest rates on hold in July.
With inflation projected only to return to the target band in the second half of 2017, and continued upside risks to the inflation outlook, the MPC may decide to continue on its interest rate hiking cycle in July.
However, with a total increase of 200 basis points since the start of 2014, there are signs that the interest rate hiking cycle could soon come to an end.
The above economic trends suggest that the MPC may have room to manoeuvre and could decide to keep the repo rate unchanged, especially if the stronger rand helps to moderate inflation forecasts.
This is also the case as past interest rate increases still filter through the economy to temper the outlook for inflation. As a result, expectations that the Bank will increase the leading policy rate another 25 basis points in the second half of 2016 have recently softened.
By Maura Feddersen, Senior Advisor KPMG Economics, Financial Risk Management
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