After surprising analyst expectations to the downside in January, the South African Reserve Bank (SARB) exceeded all analysts’ point forecasts by raising rates by 50 basis points (bp) to 7.75%. While there certainly was a non-zero probability for a 50bp hike, the 3:2 voting split suggests that the “dovish” January meeting outcome was the anomaly as the SARB was firmly in orthodox mode today. While the tone of the statement was hawkish, it was not enough to suggest a reacceleration in the pace of tightening.
The market reacted in a textbook manner: the rand rallied, the yield curve flattened, and front-end swap rates repriced higher to building the probability that the SARB is not yet done.
There are numerous recent outcomes/events that likely drove the Monetary Policy Committee (MPC) to the hawkish side:
· The inflation outcomes for January and February were higher than expected, with accelerating food price inflation causing particular consternation;
· Rising food price inflation is likely to underpin inflation expectations, which were sticky or higher in the 1Q23 Bureau for Economic Research (BER) inflation expectations survey;
· The weaker rand since the start of the year has reintroduced upside risks to headline and core inflation;
· The US Federal Reserve Bank (Fed) has continued to hike rates, despite the banking sector turmoil and pending tightening in credit conditions;
· The shift in South Africa’s balance of payments from a current account surplus to a current account deficit has made the rand and, by extension, inflation more sensitive to global funding conditions;
· The elevated wage settlement in the public sector could pose upside risk to unit labour cost growth, despite subdued private sector wage dynamics and the contained trend in unit labour cost growth over the past 18 months;
· The SARB is of the view that load shedding is inflationary rather than deflationary with nascent supporting evidence in recent inflation releases.
For the SARB, which remains data dependent, it is all about building a buffer during volatile times. To be sure, the MPC’s view is that “Given load-shedding, upside inflation risks, and larger external financing needs, further currency weakness appears likely.” Hence, we view today’s 50bp hike as a risk management exercise to buy some insurance for ongoing global market volatility.
Explicit forward guidance remains absent, but the MPC seems more comfortable now with the alignment between the level of the repo rate and the macro outlook. In particular, the SARB stated, “The revised repurchase rate is now less accommodative and is more consistent with the current view of risks to inflation.”
Yet data dependence and the Fed’s significant influence make it difficult to have a high conviction view on the outlook for monetary policy. Even so, this renewed “front-loading” of policy tightening should mean that the need to keep hiking is now lower. As such, our base case is that if the rand is well behaved, inflation expectations stabilise or fall; and the Fed is near completion, then the SARB will be able to keep the repo rate steady at 7.75% for the time being.
However, we should consider the alternative scenario of renewed rand weakness, a higher terminal US policy rate, and sticky domestic inflation. Should these materialise, then the SARB will clearly not hesitate to hike rates again. There are clearly many “ifs, buts and maybes” that the market will have to digest in the coming days.
SARB to remain conservative
The debate has already shifted to the timing and extent of the easing cycle. Our bias is that the SARB remains orthodox and risk averse. As such, we think the MPC will be reluctant to cut rates early or aggressively in the absence of a major growth destructive non-inflationary crisis. In the pre-Covid interest rate cycle, the SARB lagged the rate cuts that came through from other emerging market central banks, despite weak growth and falling inflation. We think the more challenging global funding backdrop combined with SA’s current account deficit and less positive fiscal outlook could again lead to a reluctant and delayed easing cycle this time round.