02 Aug 2017
Interest rate note: SA’s current rate cutting cycle will likely be shallower than previously
South Africa’s recent, unexpected 25bp cut in its repurchase rate is likely the start of a shallow interest rate cutting cycle in the face of the secular stagnation of the economy.
With a systemic global economic recovery under way the SA economy is out of kilter, and the Reserve Bank has taken the opportunity of an expected moderation in inflation to push through the cut.
After its knee jerk reaction on the day of SA’s recent interest rate cut, the rand moved stronger, reaching R12.86/USD as the rate cut was perceived to be (moderately) growth stimulatory. A 25bp interest rate cut adds an estimated 25bp to GDP growth, while a 25bp hike subtracts similar from economic growth, over a twelve to eighteen month period.
The rand’s strength ensuing from the start of SA’s latest downwards interest rate cycle (20th July 2017) proved to be short lived on the publication of Moody’s SA sovereign report over a week later (as well as communication on the planned gradual unwind of the Fed balance sheet). Moody’s remaining negative outlook signals its intention to downgrade SA’s credit ratings again.
Specifically Moody’s commented that “(t)he SARB’s decision comes in the context of better than expected inflation data, and should support aggregate demand, near-term growth as well as fiscal consolidation. However, without decisive structural reforms longer-term potential growth and the fiscal outlook will remain subdued and continue to be a source of credit pressure.”
Moody’s raised concerns on “growing political pressure for less independent monetary policy, a key pillar in our assessment of South Africa’s gradually deteriorating institutional strength It also sends another unclear signal about the policy direction at a time of very low and falling business confidence, and coincides with governance issues at state-owned enterprises.”
The negative outlook means SA will eventually lose both its local currency (LC) and foreign currency (FC) long-term sovereign debt (LSD) investment grade (IG) ratings unless Moody’s outlook changes to neutral or positive. The loss of SA’s IG LC LSD credit ratings from Fitch and Moody’s would likely cause the rand to move into the down case (Fitch also has SA on a negative outlook).
Moody’s next assessment of South Africa’s creditworthiness is due on 11th August 2017, with the agency expected to leave SA’s ratings unchanged after its recent downgrades, but maintain the negative outlook. Should SA be downgraded by Moody’s this year, the more likely risk is the loss of the FC LSD IG rating at the November assessment, rather than in August.
Moody’s view is that “(p)olitical pressures on the SARB to maintain expansionary monetary policies are likely to prevail, alongside heightened pressures for fiscal spending”. On the monetary policy front the SARB’s rate cutting cycle is likely to be tempered by the stickiness of CPI inflation towards the upper end of the 3-6% CPI inflation target.
State administered prices, particularly electricity and water tariffs, are expected to see significant increases going forwards from next year, at or close to double digits. These, along with other high state administered price increases exert upwards pressure on CPI inflation, and so keeps it near the upper limit of the inflation target.
Barring any downside shocks to inflation in SA, such as severe rand appreciation (a low probability of 11%) or a sharply falling oil price back towards US$20/bbl (also a low probability for this year or next), CPI inflation is not expected to fall to, and then remain close to, 4.5%, the midpoint of the inflation target range the SARB is targeting.
Consequently, it is unlikely SA will experience as substantial a fall in interests as occurred in previous, recent rate cut cycles. The last one (2008 to 2012) saw the repo rate fall by 7.00, from 12.00% to 5.00%, while the 2003 to 2005 cycle saw the repo rate fall by 6.50%, from 13.50% to 7.00%.
Besides the likely stickiness of CPI inflation towards the upper band of the inflation target range over the next few years, SA’s current interest rate cut cycle is starting at a lower point, from a repo of 7.00%. SA needs to maintain a substantial rate differential above the bank rates of developed economies (which are currently closer to 0%) if it wishes to avoid significant rand depreciation.
We expect a 25bp cut at the September MPC meeting (with the possibility of a 50bp cut instead). Further interest rate cuts in SA will depend, amongst other factors, on the CPI inflation outlook, exchange rate movements and SA’s credit ratings.