SARB policy stance softer on improved inflation outlook

The Monetary Policy Committee (MPC) of the South African Reserve Bank (SARB) highlighted the improvement in inflation outcomes and the decline in inflation expectations since its last meeting in January. According to the SARB, headline inflation should remain in the target range of 3 - 6% over the forecast period (2018-2020), averaging 4.9% in 2018, a slightly higher 5.2% in 2019, and 5.1% in 2020. A peak of 5.5% is expected around the beginning of 2019.

While these developments are favourable, SARB Governor Lesetja Kganyago noted the MPC would prefer to see inflation expectations anchored closer to the midpoint of the target range (i.e. 4.5%). Nonetheless, the MPC was of the view that the improved inflation outlook and the moderation in risks to the forecast gave room for a more accommodative monetary policy stance in March. The MPC reduced the repo rate by 25 basis points to 6.5%, bringing the prime lending rate to 10.0%. Four MPC members preferred a reduction while three members preferred an unchanged stance.

VAT impact balanced by resilient rand exchange rate

The SARB expects the one percentage point increase in the VAT rate announced in February to add about 0.6 percentage points to the headline inflation trajectory over the next year, with small second-round effects persisting thereafter. However, the improved exchange rate has tempered the impact of the indirect tax adjustments on the inflation forecast. According to the SARB, since the January MPC meeting, the rand has appreciated by 4.8% against the US dollar and by 3.5% on a trade-weighted basis. At current levels, the SARB assesses the rand to be slightly overvalued, and further strengthening potential is likely limited.

Economic growth outlook stable but challenging

The domestic economic growth outlook for this year is more favourable but remains challenging. Following an annual growth rate of 1.3% in 2017, the SARB expects a growth figure of 1.7% for 2018 compared with 1.4% previously projected. The forecast for 2019 is 1.5%, while a growth rate of 2.0% is estimated for 2020. The improved growth outlook is driven primarily by an increase in business and consumer confidence, which may boost fixed capital investment over the forecast period.

Fewer interest rate hikes expected by end-2019

The MPC assessed the risks to the inflation outlook to be balanced, with many domestic risks and uncertainties having abated in recent weeks. The 2018/2019 fiscal budget was well received, and last week’s sovereign ratings outcome was positive for the rand exchange rate. The rand will remain sensitive to a faster-than-expected pace of monetary policy tightening in advanced economies, possible heightened global financial market volatility, as well as domestic developments.

The implied path of policy rates generated by the SARB’s Quarterly Projection Model has therefore changed since the previous MPC meeting.

SARB interest rate forecast, January 2018

SARB interest rate forecast, January 2018

SARB interest rate forecast, March 2018

SARB interest rate forecast, March 2018

While in January, the model indicated two to three increases of 25 basis points each before the end of 2019, the model now suggests only one increase of 25 basis points. Two further increases may be required in 2020. The implied path produced by the SARB’s modelling tool constitutes only a broad policy guide, which reflects shifts in either direction in response to new developments and changing risks to the inflation outlook.

The more accommodative outlook for the interest rate path, as well as the reduction in the repo rate in March reflect recent improvements in the inflation outlook. Key factors that may shift this outlook over the coming months include movements in the rand exchange rate and the outcomes of ongoing public sector wage negotiations.

The MPC will meet again in May to deliberate a suitable interest rate stance, with a decision expected on Thursday, 24 May.

Article by Maura Feddersen, Economist at PwC, Strategy&

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