Rates Watch May 2017: Where to now?

It’s Monetary Policy Committee (MPC) meeting time again! Oh and in case you were wondering: the MPC is a group within the South African Reserve Bank (SARB) that meets around 6 times a year to determine whether interest rates in the country should be changed or not.

The SARB has set its sights on a target inflation range of between 3% and 6% and it manipulates interest rates to stay within this range where possible. And so, while the MPC assesses various economic factors (and probably political ones too, though they deny it) when making its decision the one they pay closest attention to is inflation.
Since September 2016 inflation has remained stubbornly above the upper end of the target range peaking at 6.8% in December. The trend since January 2017 has, however, been downward and the current forecast suggests that inflation will come in at 5.8% for April. We will know around midday today if this is in fact the case.

The environment: Sovereign downgrade and lower inflation?

Economic growth remains anaemic and further Ratings Agencies downgrades are expected. Taxes have increased and retailers and service providers have all hiked their prices. The government offers little direction and political shenanigans have spooked investors and consumers. Yet the JSE is close to 52 week highs and inflation is falling. How?

Firstly, cautious consumers and businesses mean that spending is depressed and this means that demand is down. Demand is one of the biggest drivers of inflation.

Secondly, while poor rainfall persists in the Western Cape, the end of the drought in the rest of the country has seen crop yields rebound and this has resulted in downward pressure on food inflation and this is likely to continue if yields are sustained. Food prices will continue to drop, perhaps significantly, as producers, processors and retailers finally pass savings on to consumers (if collusion and price fixing can be effectively rooted out!).

The Rand, despite a degree of volatility, has not reached the R16 level against the Dollar most expected after the cabinet shuffle and first downgrade. This is, unfortunately, the result of Dollar weakness and not Rand strength, so don’t get too happy just yet. But this has meant that import costs have remained stable for the first half of the year as Oil prices remain stable (and relatively low), also exerting downward pressure on inflation. This can all change should positive sentiments toward the Dollar and the Trump administration return.

Finally, investors, after initial shocks, have returned to the JSE in search of returns not yet available in the US and other developed markets. Like the benefits from Dollar, this appetite for higher yields is subject to changes in sentiment and likely to occur when the remaining Ratings Agencies downgrade South Africa to junk status.

So, what will the SARB do?

Well, we’re not going to get an interest rate cut. There is no reason to do this and inflation must continue its downward trend until at least July for this to be considered. Slow economic growth and depressed consumer and business confidence means that an interest rate increase is also highly unlikely: increasing the cost of debt will only make things worse for South Africans.
It is my prediction then that the Reserve Bank will keep the repo rate at 7%, making this the 14th consecutive month at this level. Prime lending (the baseline at which banks lend to customers) will therefore remain stable at 10.5%.

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