24 May 2017
MPC preview: in this interest rate outlook we continue to expect no change in the repo rate this year, with CPI inflation above midpoint in the target period
The Monetary Policy Committee (MPC) meets this week and is expected to leave the repo rate unchanged at 7.00%. The recent credit rating downgrades are not expected to precipitate an interest rate hike in South Africa this year, with the impact on the rand and bonds proving limited in the global risk-on environment.
Foreigners have favoured local currency emerging market (EM) debt given the lower yields in developed economies, particularly the Euro area and the rand’s post-downgrade strength reflected the continuation of this global risk-on appetite, with SA still attractive in this respect as the country retains two investment grade ratings on its local currency denominated long-term sovereign debt. The rand itself is ‘undervalued’ both on a fair value (or purchasing power parity, i.e. PPP) and real effective exchange rate basis, and could have room for some further, limited strength over the medium-term, amidst likely volatility.
CPI inflation is waning and is expected to fall to 5.0% this year on some alleviation of the drought (see “Economic outlook 2017 – 2022: South Africa’s economic growth likely to remain below that of both sub- Saharan Africa and world growth, 12th May 2017), with a bumper crop anticipated, although some areas are yet to have meaningful relief, and will likely take more than a year to recover due not least to farm debt. Even if rain relief comes to the regions, meat price inflation will battle to recover in particular. El Nino (drought) remains a risk for year end. Agbiz has stated that the “overall summer crop production is estimated at 16.9 million tonnes, which is an 80% annual increase”, “(t)he most notable increases are in maize and soybeans. Total maize production is estimated at 14.5 million tonnes, which is the second- biggest crop on record after 1980/81 season. Soybeans are set to be the biggest on record, estimated at 1.2 million tonnes.” Consequently, our inflation forecasts fall, but not permanently (see figure 1).
The SARB is also pencilling in further credit rating downgrades as a high risk for rand weakness. However, commodity prices are believed to have stabilised for the next two years (see figure 8) which will be a positive for the rand (if we avoid further credit rating downgrades). We see a 50/50 chance of further sub-investment (SG) downgrades to SA’s local currency (LC) long-term sovereign debt (LSD) as the down and expected cases are equally weighted (see “Risk update: probability of extreme down case rises to 19%, up case drops to 10% on downgrades, baseline case weaker growth and rand”, 18th May 2017). On the topic of probability scenarios it should be noted that previous fears of heightened strike action and electricity blackouts (that prevailed in 2014 see “Macro-economic update and outlook”, 4th August 2014) have reduced with the improved working relationship between business, labour and government on the former, and new power station builds on the latter, with incoming units from Ingula, Medupi and renewable energy, along with the first unit from Kusile expected this year, and the possibility of Inga dam in the future (see “Electricity update: production improvement with unit synchronised to grid”, 31st March 2016).