The decision of the Monetary Policy Committee was again not unanimous, with three of the members in favour of keeping rates on hold and two members in favour of a rate cut.
Forward Rate Agreement (FRA)
FRA rates were not expecting a 25bps rate cut but nonetheless increased by about 6bps to 3.37 % after the announcement. A key focus in the coming month will be where the 3-month Johannesburg Interbank Agreed Rate (JIBAR) rate could settle (currently at 3.34%).
In the past week, there was a slight steepening in the money market curve, with the 12-month JIBAR rate rising 13bps to 3.58%, after trading up to -5bps below the repo rate. While there remains a probability of a late rate cut in 2021, we believe the key driver needs to be a moderation of the inflation outlook on a rolling 12-month basis recede to below 3.5%. Fiscal risks are expected to remain elevated in 2021.
Marginal downward revisions to the inflation forecast as expected
Headline and consumer price index (CPI) inflation forecasts for 2020 and 2021 were revised to 3.2% (previously 3.3%) and 3.9% (4.0%) and left unchanged for 2022 at 4.4%. The assumptions responsible for the slightly lower inflation trajectory were a slightly stronger rand, the starting point was at R16.50 to the US dollar from R17.07, a lower oil price and lower inflation expectations. Food price inflation is expected to remain contained.
The South African Reserve Bank (SARB) flagged the potential large effect of medical aid tariffs on near term CPI inflation if price increases were to be postponed from February to July 2021. But we believe that the MPC will look through this if inflation in H2 21 approaches 4.0%. The pass-through from the depreciation of the rand is expected to remain muted.
The overall risks to inflation in the near term is to the downside but balanced over the medium term. The key upside risks emanate from the fiscal position to the rand and electricity price increases. The MPC noted that the budget deficit has been funded by domestic savings and international financial institutions (IFIs). While the current account is expected to register a small surplus of 0.5% of GDP in 2020 (which is an improvement from the previous forecast of -1.0% of GDP), foreign savings remain critical to supplement domestic savings to finance the budget deficit and infrastructure plan.
Small improvement in 2020s GDP growth forecast
A strong rebound in mining and manufacturing production and retail sales in Q3 20 has seen an upward revision of the SARB’s Q3 2020 GDP growth forecast from 35% q-o-q seasonally adjusted and annualised rate (saar) to 51% q-o-q saar. The 2020 forecast has been raised from -8.2% to -8.0%. However, the higher base has resulted in the forecast for 2021 downgraded from 3.9% to 3.5%. The SARB noted again that monetary policy cannot lift the potential growth rate of the economy or reduce fiscal risk.
Stable inflation drivers
- Goods producer prices and food inflation appear to have bottomed.
- Oil prices remain low.
- Local food price inflation is expected to stay contained.
- The pass-through effect from the depreciation of the rand remains low.
- There are no demand-side pressures evident.
Upside risks emanate from the following
- Electricity and other administered prices;
- Exchange rate pressures from heightened fiscal risks.
The tone of the MPC statement was neutral. While a negative real policy rate is currently warranted by the challenging economic backdrop, the 12-month forward outlook supports a sideways movement. The SARB’s quarterly projection (QPM) model continues to signal two rate hikes of 25bps each in Q3 and Q4 2021 and a total of 91bps in 2022. We are of the view, however, that the repo rate could move sideways in 2021.