Difficult to call Sarb's next rate move

Cape Town - The latest inflation figures are due on Wednesday and the Monetary Policy Committee (MPC) of the SA Reserve Bank (Sarb) will announce its latest decision on the interest rate on Thursday.

At the same time the rand has weakened and the oil price was lower.

Fin24 asked experts to make some predictions.

Gina Schoeman, Citi’s economist for South Africa, forecasts that the repo rate will remain unchanged at 5.75%.

Schoeman foresees that the August Consumer Price Index (CPI) will slow.

"We forecast a slight slowdown to 6.2% year-on-year, affirming a downward trend since the 6.6% peak in June," said Schoeman.

"The risk to our forecast is slightly to the upside - given a second decimal forecast result of 6.25%. However, this would not detract from our view of a downward, albeit sticky, trend in CPI from here on."

As for the iinterest rate, she expects the Sarb to downgrade its 6.6% fourth quarter 2014 CPI peak.

"In addition, the Sarb only has to tolerate another two quarters of above-6% CPI which, in the face of weak GDP is reasonable," said Schoeman.

"The rand variance has picked up this month, but we continue to believe that the Sarb prefers to hold on to as much ‘ammunition’ as possible when faced with a weak domestic demand. To this, we believe the Sarb may revise its GDP outlook down again."  

Chris Botha, senior fund manager at Imara Asset Management SA, told Fin24 Sarb is in a difficult spot.

"Local economic growth is struggling and consumers are highly indebted, which is being reflected in declining consumer expenditure and confidence, particularly in the middle to lower LSM markets," Botha told Fin24.

"Despite this, however, the main issue for them rests with the widening current account deficit, which is being funded by foreign portfolio flows - short term money, not fixed investment."

He said a widening current account deficit correlates highly with a weaker rand, which in turn increases inflationary pressures.

"We think inflation has peaked though and it is therefore rather important to have a stable rand for this scenario to hold. The problem they are facing is the timing of rising interest rates in the US," said Botha.

"To protect the funding of the current account deficit, they will have to align our interest rate cycle with that of the US to keep foreign investors here - in other words - offer alternative attractive yields to maintain  foreign investment funding of the current account deficit and stabilise the rand."

Communication and action by the US Federal Reserve will remain the main driving force for global investment markets, in his view.

Two main focus areas

The two main focus areas which will determine the timing and size of an interest rate hike in the US remain the state of the labour market and inflation. The official unemployment rate has steadily been declining edging closer to the Fed’s 6% target level. The current unemployment rate of 6.2 % has declined by 1.1% over the past 12 months.

Despite the positive trend, the Fed continues to voice concern regarding the low rate of wage growth and slack in the labour market – fewer jobs, but lots of labour.

At the recent economic congress in Jackson Hole, chairperson Janet Yellen noted that the continued low rate of wage growth points to “weaker labour market conditions than would be indicated by the current unemployment rate”.

Botha said the Fed will likely only start raising rates when wage growth starts picking up and the unemployment rate drops to below 6% on a sustainable basis.

"Given current indications, it is likely that US interest rates will probably only be hiked in the second half of 2015, but could change sooner and more aggressively if the Fed falls behind the curve if inflation surprises on the upside and wage growth gathers pace," said Botha.

"Globally, inflation remains very subdued with consumers still deleveraging and it is therefore, likely that inflation will remain low for some time due to the lack of consumer expenditure."

The Fed, in Botha's view, is very aware that a premature rate hike might derail the fragile recovery which could cause them to cut interest rates soon after hiking to ensure a sustained recovery.

"It is highly  possible that the next hike in local interest rates could be postponed until next year, given the above analysis. The main risk to our view remains a weakening rand, which could cause inflationary expectations to increase," said Botha.

"We, therefore, expect short term interest rates not to be hiked in the upcoming meeting."

Peter Attard Montalto, Nomura's emerging markets economist, said although he expects rates to remain unchanged at 5.75% at the Sarb MPC meeting this Thursday, he thinks the possibility of a hike is about 40%.

"South African monetary policy is in a transition period as we approach year-end, between the relative calm of most of the rest of the year, when the Sarb had space to balance growth and inflation concerns and the period through the first half of next year, into Fed hikes in June - in our view - when we expect more real rate normalisation by the Sarb," said Montalto.

"The shift in the size of hike at the last meeting to 25 basis points (bp) makes this meeting also unusually difficult to call."

"The Sarb will likely slightly increase its inflation forecast after recent prints (particularly core inflation) and with underlying currency pressures feeding through."

This has been reflected in recent rhetoric from the MPC on mounting concerns about the level of price pressures.

The recent currency moves have been meaningful and though the rand has broken out of the range it has been in since the start of June, it has not reached the highs of January.

Offsetting this has also been the much lower oil prices - down some 6% even in rand terms on the key Dubai benchmark useful to South Africa - while local raw food prices such as maize have remained around their lows after falling sharply through the second quarter.

"Hence, we think the Sarb may well maintain its upside risks to the CPI, but the situation should not have meaningfully deteriorated from the last meeting,"said Montalto.

"However, the Sarb’s growth forecasts are likely to fall further still after the recent GDP prints and the quarterly bulletin breakdown. As a reminder, the Sarb currently forecasts 1.7% GDP growth for this year compared to our own 1.6% forecast and 2.9% for next year compared our own 2.5% forecast."

However, after recent GDP prints Nomura has increasingly highlighted the downside risk even to its own forecasts.

However, Montalto points out that the latest quarterly bulletin saw lower wage pressures coming through to the economy as a whole in the second quarter.

"We think the Sarb will retain a degree of concern about a wage or inflation spiral, but this issue should now take more of a back seat," he said.

"The inflation and growth balance remains a worry for the Sarb, with concerns about the CPI in particular, but there is no clear shift in this growth and inflation balance."

International backdrop

The complication at this time is the international backdrop.

"We have long believed that, once markets globally started to see the Fed hikes as much more immediate, the MPC would be ready to undertake more regular hiking to normalise real rates. This view was conditional on such a backdrop developing into more stress around South Africa that ultimately was seen by the Sarb as an increased threat to CPI inflation," said Montalto.

"However, the view was also premised on the fact we think the Sarb only wants to be 'at' the curve, not ahead of it. As such, at this juncture, we think it is a little early for the Sarb to start normalising real rates – a little too ahead of the curve."

The Federal Open Market Committee (FOMC) meeting on Wednesday - the day before Sarb's MPC meeting - might shake things up, however, if the committee is particularly hawkish," explained Montalto.

"The 2017 'dots' of the FOMC members' forecasts will contain important information about terminal rates that will feed into the Sarb’s thinking on South African real rates."

He said that put simply, compared with January the situation is not nearly bad enough on this front to warrant the Sarb being ahead of the curve.

"The flow situation certainly requires MPC hawkishness in the statement, in our view, and maybe a large dollop of semi-pre-commitment for the November meeting, but the case does not seem to be there fully at this time," he said.

Mabyanine Phiri, portfolio associate at ACM Gold, pointed out that during the previous meeting of the Sarb MPC it put forth a stance that suggested an interest rate hike phase.

"However, there is contention as to whether further tapering of the asset purchase programme from the US, which is to conclude end of October, will be followed by a rate hike before 2015 and cause the Sarb to take a different stance, or whether the stimulus from the ECB will be sufficient to support the gradual increase in domestic interest rates," said Phiri.

“There seems to be a more positive outlook on the impact of the coinciding ECB stimulus programme with regards to the rand. Inflation outlook and the global economic situation has changed considerably in the last two months and has worsened due to declining food and oil prices."

The Sarb is most likely to revise the inflation forecast for the last Quarter of 2014 to approximately 5.9% and Phiri also expects the Sarb will keep the repo rate on hold at 5.75% for the remainder of the year.”

Mike Schussler, director of economists.co.za foresees a small reduction in the petrol price of about 2 cents.

"But the fact is, there will be no big change unless the rand falls further. The dollar is strong, which pushes commodity prices down and the rand weaker too," he said.

"This results in dollar product prices declining, but the rand to a large extent wiping out those gains. So, what ever happens, the change should be small and will be in single digits either way. With the price over R13 this means the change will be less than 1%."

He said, however, that since the price declined a lot this month, it could be more stable at lower price levels for another month or three and could actually give motorists and transporters some room to breathe.

"This may also help the inflation rate decline and that could help to limit rate hikes - some of which we will still get," said Schussler.

"The upward movement in the Consumer Price Index (CPI) will be paused at least for a few months, which consumers also desperately need."

It could also help the current account slightly if the oil price remains low, as that is SA's biggest single import commodity.

"Overall if the petrol price, after rising sharply over the last two years, takes a three month break in big increases after a decrease, could be one factor that would help the economy get a little more traction," he said.