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16 May 2018

MPC preview: an unchanged interest rate decision is likely in May

Annabel Bishop

Chief Economist

with higher interest rates more likely in the longer term

Figure 1: SA Consumer Inflation: history and forecasts

Recent market volatility, and marked risk-off (heightened investor risk aversion), has seen foreigners particular sellers of rand equities and bonds, with the IIF showing that last week South Africa saw the biggest portfolio outflows compared to other EMs. Portfolio inflows on SA’s capital account significantly finance the deficit on its current account, and so the rand remains very vulnerable to substantial global market swings. Currency weakness feeds through fairly soon into higher inflation for South Africa, and the trade weighted rand is currently 4.1% weaker than at the last MPC meeting, with particular weakness against the US dollar. The SARB will likely adjust its exchange rate forecast weaker (and oil higher) in its model, leading to higher inflation forecasts over its forecast period at its May MPC meeting. Volatility in financial market indicators is likely for most of the rest of the year, particularly in EMs (emerging markets). In particular, the IIF (Institute of International Finance) shows portfolio flows into EMs of US$2.5trillion since the global financial crisis and resultant very low global interest rate environment generally for developed economies. A reversal of even a significant part of these flows would likely cause severe depreciation of EM currencies. The US economy is indubitably in a rate hiking cycle, indicated out to 2020 by the FOMC (see figure 2). Globally, with economic growth running above its potential, (see “Macro-economic outlook 2018–2024: Global growth strengthens, for SA structural reforms are outstanding now the politics have subsided”, 9th April, website address below), inflationary pressures are expected to emerge, placing some upwards pressure on US inflation from 2019, and so negatively impacting investor sentiment and EM currencies (see “Rand note: rand plunge towards the down case in late April temporary shift toward the down case, as global markets recalibrate US inflation (and interest rate) expectations). The risk for significant rand weakness is clear. With the SARB highly unlikely to be in an aggressive rate cutting cycle, we expect no change in the repo rate at the May MPC

Figure 2: Forecasts
Figure 3: Evolution of US interest rate expectations

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