On 23 and 24 January, the Monetary Policy Committee (MPC) of the South African Reserve Bank (SARB) will meet for the first time in 2017 to agree on a monetary policy stance that will coax consumer inflation back into the target range of 3% to 6%.
In view of current economic conditions and expectations for 2017 and beyond, the Reserve Bank will likely keep the repo and prime interest rate at 7% and 10.5%, respectively. In essence, three factors prompt this expectation:
Data released by Statistics South Africa (StatsSA) indicates the consumer price index (CPI) increased by 6.8% year-on-year (y-o-y) in December 2016. This was slightly above the consensus view of 6.7%, but aligns with the SARB’s expectations that consumer inflation would peak towards the end of last year.
At 12% y-o-y in December, food price inflation, fuelled by the devastating impacts of the drought last year, remains a key driver of headline inflation. Better rainfall during the summer, so far, suggests that food price inflation may ease in coming months. This could offer the Reserve Bank greater scope to adopt a more accommodative monetary policy stance sooner.
Taking into account easing food price inflation, SARB Governor Lesetja Kganyago stated in November that inflation will likely fall below 6% y-o-y by the second quarter of 2017. Thus, if economic trends confirm that consumer price inflation is softening and will return to the target range by mid-2017, the MPC may be prompted to keep interest rates unchanged in January. Indeed, various institutions support the SARB’s view that the inflation rate will decelerate in coming months.
CPI inflation rate expectations (% change, y-o-y), by date of publication
Governor Kganyago has highlighted that the MPC is conscious of the economic growth implications of higher interest rates.
Indeed, economic growth expectations remain worryingly low. The Barclays Purchasing Managers’ Index (PMI) stood at 46.7 index points in December, suggesting that the manufacturing sector may have underperformed in the last quarter of 2016. Furthermore, although retail sales increased by a healthy 3.8% y-o-y in November, the improvement may have been fuelled by Black Friday deals and could be short-lived. December’s retail sales data will be essential to signal a possible economic turnaround.
A number of institutions expect real GDP growth in South Africa to remain low, averaging between 0.8 and 1.8% over the next two years:
Real GDP rate expectations (% change, y-o-y), by date of publication
Following much anticipation, the Federal Open Market Committee (FOMC) of the US Federal Reserve (Fed) raised the target level for the federal funds rate by 25 basis points (bps) in December last year. This was a signal that the Fed now views the economic recovery in the US resilient enough for a stricter monetary policy stance that will start counteracting years of quantitative easing.
Locally, the Reserve Bank has been keeping a close eye on changes in US monetary policy. An increase in interest rates in the US means investors will seek greater returns on secure US government assets. Without an accompanying increase in interest rates in South Africa, the drop in the relative interest rate between South Africa and the US could precipitate an outflow of capital funds, a consequent weakening of the rand exchange rate and therefore greater risks of imported inflation. Although the exchange rate initially weakened 3% against the greenback following the Fed’s interest rate decision, the rand has since recovered, averaging R13.63 against the dollar in January to date. Recent rand strength suggests US monetary policy developments may not currently necessitate a tighter monetary policy stance at home.
The balance of risk?
In light of low economic growth and expectations of slowing consumer inflation locally, as well as tentative US monetary policy tightening, the Reserve Bank is expected to keep the repo rate on hold at 7% in January. Looking ahead, another round of decisions on South Africa’s sovereign investment rating looming this year, as well as unpredictable international events, will influence whether the Reserve Bank can confirm an end to its interest rate hiking cycle in 2017.
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