SARB cuts rate: When hawks turn into doves

17 Jan 2020

Tertia Jacobs

Treasury Economist

The Monetary Policy Committee (MPC) of the SA Reserve Bank cut rates by 25 basis points to 6.5%, while issuing a statement that was more dovish in tone than its previous hawkish statements.

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The MPC decision in a nutshell

Outcome of MPC meeting: Repo rate lowered by 25bps (0.25 percentage points) to 6.50%
 
Members’ decision:  Unanimous decision by all five members vs November 2019’s vote (three to leave rates unchanged, two in favour of a cut)
 
Tone of statement: Dovish bias
 
Rationale behind the rate cut:
 
  • The CPI inflation forecast for 2020 revised was revised lower, while inflation expectations continued to moderate and GDP growth forecast marked down.
  • Fiscal risks remain but the more benign inflation outlook provides some comfort in the event of adverse developments materialising in coming months.

What changed the minds of the hawks?

The decision to cut the repo rate by 25bps at the January MPC meeting was not entirely surprising, what was surprising was that it was a unanimous decision, supported by all five MPC members.
 
In November, the hawks had the upper hand, with three of the five members in favour of keeping rates unchanged. The more cautious approach had been motivated by the wide country risk premium, driven by risks from the fiscus, which in turn increased the likelihood of a Moody’s downgrade in 2020 and possible rand weakness.

The inflation outlook in 2020 appears to have improved. The average inflation rate was lowered from 5.1% to 4.7%. Inflation outcomes in 2019 have consistently surprised on the downside, resulting in a lowering of the average inflation rate forecast from 4.8% to 4.1% during the year.

The outlook for 2020 was steadier, at around 5.3% to 5.1% but was lowered to 4.7% at yesterday's meeting. Core CPI inflation for 2020, often seen as a proxy for second-round inflation and demand-pull pressures in categories such as housing inflation, was also lowered from 4.6% to 4.4%.

Inflation expectations, an important contributor to the SARB’s inflation forecast, have continued to moderate and most likely played a role in the dovish take on the appropriate stance of monetary policy at this juncture.
 
The Reserve Bank has long reasoned that the moderation in consumer spending was caused by employment prospects, which are largely structural and outside monetary policy’s ambit to fix.
 
A rate cut at this juncture will mainly improve cash flows of indebted households. For business and consumer confidence to revive, more is needed and this is where developments over the next few months will provide more direction. 
Tertia Jacobs, Treasury Economist, Investec

"The key drivers we are monitoring include: the government adopting a more urgent stance in reviving growth, the public sector wage bill and developments at Eskom."

Tertia Jacobs, Treasury Economist

How does the MPC view rating risk?

In our view, fiscal risks have deteriorated by even more than had been suggested in October 2019, when the Minister of Finance tabled revised forecasts of the macroeconomy and fiscal metrics.
 
The MPC warned that “the domestic economic outlook remains fragile.” GDP growth forecasts for 2020 are in the process of being revised lower. The SARB lowered its 2019 GDP forecast from 0.5% to 0.4% and 2020 from 1.4% to 1.2%. CIB’s forecast is nearly half that of the SARB’s for 2020, standing at 0.7%. The divergence can mainly be ascribed to CIB factoring in more of a load shedding impact on productivity and growth.
 
Rating risk therefore remains ever-present. The key drivers we are monitoring are:
  1. The government adopting a more urgent stance in reviving growth.
  2. The public sector wage bill and
  3. Developments at Eskom.
 
The more hawkish MPC members probably drew comfort from indications that the moderation in inflation could be more sustained around the midpoint of the target band. And in the event of a rand selloff and depending on the magnitude and the consolidation range, an acceleration in inflation may not necessarily elicit an aggressive response which could create further headwinds for the economy. 

Global growth has bottomed, although geopolitical risks remain elevated

The international backdrop has improved somewhat following the slowdown in 2019, driven by trade tensions, an increase in tariffs, a contraction in global manufacturing and a slowdown in trade.
 
Monetary policies in the advanced economies are expected to remain accommodative and inflation contained. Many investors and corporates view geopolitical risk as one of the biggest risks to markets and economies.

 

Dovish tone of the statement

 
The tone of the statement was dovish with the balance of risks to inflation deemed to be neutral. The Quarterly Projection Model (QPM) of the SARB’s implied rate path indicated two rate cuts in 2020, compared to one rate cut at the November MPC meeting, of which one was delivered in January.
 
The MPC noted that the persistently uncertain environment implies that future policy decisions will continue to be highly data dependent, sensitive to the balance of risks to the outlook, and will seek to look through temporary price shocks. 

Market reaction

The dovish tone and contained inflation outlook have seen the Forward Rate Agreement (FRA) market adopting a bias towards another 25bps rate cut in Q2 20.
 
Money market rates are expected to decline by between 20bps (at the short-end) and possibly 10bps or so out to 12 months. The front-end of the yield curve has rallied, with the yield on the R186 8bps lower at 8.20%.
 
However elevated fiscal risks, a large amount of government bond supply and rating risk are expected to keep the slope of the yield curve steep. The reaction of the rand has been muted, trading in a range of 14.35 to 14.45/$ immediately before and after the MPC’s announcement.