The MPC was always going to have an easier ride for its natural hawkish bias today after the volatility since the US elections and the upside surprise to inflation this week. Nevertheless, we were still slightly surprised by the (welcome) candour of the assessment of the US policy landscape under a new administration including comments on protectionism. The SARB notes the market’s pricing in of more rate hikes for the Fed and the strong USD and worries about the impact on vulnerable emerging markets like South Africa. It sees more uncertainty, a more volatile ZAR (though noting its resilience) and more future downside risk to ZAR.
This has driven an increased hawkishness overall in the MPC statement – from soft-hawkish last time to medium hawkish this time. The key hawkish part was right at the end where the caution of the last two meeting’s statements on future hikes, signalling that the end of the cycle was close, was pared back. As such, the statement mentioned the need for “vigilance” and that “while the Committee retains the view that we may be close to the end of the hiking cycle, there may be a reassessment of this position should the upside risks transpire.” This compares with the previous statement which said that the forecast transpiring would mean the cycle was towards the end. The Q&A of the press conference went slightly further; when asked if a hike was discussed, the reply came that there was “no proposal” voted on to hike at this meeting (indeed, it was a unanimous decision to hold with no discussion of a cut) while there was discussion about the factors that could lead to further hikes in the future. The skew in risk around rates therefore seems clear.
On the neutral side, however, were domestic factors. The growth narrative remained unchanged, as it has done despite forecast revisions for the last three years. Forecasts were kept unchanged this time for GDP. On inflation the narrative shifted marginally. The MPC is highlighting that some factors like wages are now looking more favourable, with real wage growth being more responsive to the loose labour market (a dovish comment). On food prices, the MPC expects a little more downside risk through next year in some areas but offset by a later peak in meat prices (overall broadly neutral from previously being a hawkish concern). Indeed, forecasts were revised down very marginally for headline and core for H1 next year (as expected), but the long end forecast was kept unchanged for headline at 4.6% for Q4 2018 and down only a tick for core in that period to 5.3%. What has changed, however, is the MPC’s view on inflation risk over the medium run from “balanced” at the last two MPC meetings to “moderately to the upside” now. This is being driven by the external risks offsetting the domestic risk factors.
Given the stickiness of the SARB’s growth narrative (ie, it’s basically all structural, not cyclical – the so called “no output gap axiom”) which is likely to continue, as well as the fact we don’t see the domestic drivers of inflation from wages, the labour market, administered prices or oil significantly surprising, the key routes of surprise to materialise the upside risks the MPC fears would be the currency and food.
We are actually marginally below the SARB on inflation for headline and core next year though above for 2018. One source of rate hikes could be a rise in the medium-run profile in the forecast risking target breaches. More likely would be a much shallower food price cycle next year (a risk we acknowledge in our own forecast as well as the SARB in theirs) or a much weaker currency. We have previously put 15.50 in USD as a key level at which the SARB might consider hiking. Central to this would be a dropping from the statement of the “resilience” view on ZAR which we should watch through H1.
It seems too early to be able to make a meaningful call on these upside risks to CPI materialising – especially with our forecast as it is. But with politics likely to be nosier and fiercer into next year’s elective conference, and a lack of growth likely to drive downgrades mid-next year if they don’t happen now, then we think the chance of rate hikes in H1 is very high – we currently assign about a 45% probability to a 2x25bp move.
What makes us nervous is that the US curve has already steepened markedly, and the USD is at its strongest for 14 years, yet ZAR has held in. That can change very quickly but likely unpredictably. The SARB should respond calmly to a break-out in ZAR if the market “catches up” as US policy under a new administration becomes clearer and decisions can be made regarding the composition of nominal US growth and the degree of protectionism in place. For now we keep our forecast as is.
What is very clear, however, is that rates cannot be cut in the forecast horizon with these risks in place. What we saw today was the SARB’s natural hawkish bias comes out. The MPC is happy to use whatever hawkish peg is available to hang its hat on. External risks were the issue this time. In the past it was switched deliberately between core or non-core inflation risks as needed. This is what we call the “fear cycle” and speaks to the key word in the whole statement: “uncomfortable” used when describing the CPI forecast relative to the upper end of the target. The MPC worries about inflation and thinks it can act on it, but understands it can do nothing lasting or sustainable about growth. The MPC sees policy still just below neutral, in accommodative territory, which is fine when inflation risks are balanced in a weak economy but not as those risks get tilted to the upside and then start to manifest. We think it views neutral around 7.50% which would mean removing accommodation with a move to that level if risks came through.
As such, we watch food and ZAR in the coming months (and let’s not forget expectations too), and will add hikes into our forecast if deterioration occurs. Ultimately (and this was hinted at today with the use again of the word “uncomfortable”), the SARB will be watching the long end of the forecast (Q4 2018) and how that moves, and looking through the short-run dip in inflation to see where sticky long-run pressures are. As we commented yesterday, core is proving a little stickier than expected.
We should be cautious on markets, however, in H1. The strong dip back in CPI (to a 5.1% base in May, according to our forecast, though some forecasts go a lot lower) may actually cause over-eager markets to still price in rate cuts erroneously. Such moves in front-end rates should probably not be immediately leant against but opportunities to pay rates in the front end if ZAR starts to become disconnected may well be interesting as we approach that base in CPI.
Ultimately, however, the SARB seems to have an easier job than peers – Turkey especially. Risks are certainly there, and the SARB is right to remain vigilant and conservative, but ZAR being resilient, if volatile, is giving it some room to stay on hold for now and wait and see.