The South African Reserve Bank (SARB) hiked the repo rate by 75 basis points (bp), to 5.50%. While this was larger than the consensus median, it was not entirely surprising given that the market had been assigning a reasonable probability to such an outcome. That said, the statement and the voting split – with one of the Monetary Policy Committee (MPC) members voting for a 100bp hike – were clearly hawkish. As such, a 75bp increase at the next MPC meeting should not be ruled out.
We think the key factors that led to the relatively large increment were:
· More hawkish global monetary policy, with the Fed having moved by 75bp at the June FOMC meeting;
· The weaker rand exchange rate, not only versus the US dollar but more broadly based on the circa 6% depreciation in the trade-weighted rand since the May meeting;
· The sharp increase in inflation expectations, particularly for the 5-year horizon; and
· Elevated wage settlements and the risk of inflation persistence at the core level.
While we had expected the SARB to be more sensitive to the fragile domestic growth backdrop, the bank is firmly focused on inflation and ensuring its credibility remains intact. Today’s outcome and the recent inflation data highlight that South Africa is a price-taker on global financial conditions and fuel and food price dynamics.
Given that the inflation peak in the rest of the world is not yet in the base, the SARB is set to continue to front-load policy tightening, which would imply that the neutral rate of 7.00% (as per the Bank’s model) could be reached much sooner than implied by the bank’s own forecast. This would still be below the 8.00% – 8.50% level implied by the forward rate agreements (FRAs), which are assigning a substantial risk premium in light of the highly uncertain outlook.
A more aggressive hiking cycle than currently projected would most likely require further substantial and sustained rand weakness, capital flow volatility, and a large deterioration in SA-specific factors. A sustained higher global cost of capital and a strong dollar would be headwinds to growth, but could keep inflation elevated via a weak rand.
The Fed Funds futures market is already pricing in rate cuts from the Federal Open Market Committee (FOMC) by mid-2023. If global policy does stabilise in early 2023 and ultimately reverses course, even if only partially, then it will give the SARB some breathing room. Until then, the central bank will have to ensure that the real policy rate (the nominal repo rate adjusted for inflation) steadily rises, joining all the other central banks that have been trying to out-hawk the Fed.
The larger-than-expected increase resulted in a sharp flattening in the FRA curve, but a more moderate move in the yield curve. While the rand tracked the US dollar index for most of the day, the more hawkish policy stance supported the rand in late trade with the rand 0.7% stronger on the day (with the dollar index flat at the time of writing). The impact on the equity market was limited, with retailers slightly down on the news, while the banks benefited.