The monetary policy committee (MPC) of the SA Reserve Bank (SARB) today decided to keep the repo rate unchanged at 5%. The decision was in line with market expectations and follows the - in the MPC’s words - pre-emptive 50bps reduction announced at the July interest rate meeting. The unchanged repo rate means that the prime lending will remain at 8.5%.
As was the case in July, the statement that accompanied today’s interest rate verdict expressed a greater degree of anxiety regarding the outlook for global and domestic GDP growth than concern about inflation prospects. Indeed, the opening sentence of the statement mentions that the global growth outlook deteriorated further since July. In particular, the MPC correctly argued that it was still too early to say whether recent aggressive monetary policy announcements by the ECB (sovereign bond purchase programme) and the US (quantitative easing round three) will have a lasting positive impact on financial markets and the real economy.
The continued apprehension regarding growth was reflected in a downgrade to the SARB’s domestic GDP growth forecast, especially for 2013. Growth is forecast to average 2.6% in 2012, down slightly from the 2.7% expected in July. In the Q&A session, SARB Governor Gill Marcus said it was premature to gauge the adverse impact that the most recent – and on-going in some cases – mining strikes will have on growth. The MPC statement mentions that the mining unrest has the potential to undermine the already fragile private sector fixed investment environment.
The more significant change to the growth outlook is for 2013. The SARB cut its forecast to 3.4% from 3.8% expected in July. At the time, the BER – along with many other analysts – argued that the view for 2013 was overly optimistic. The MPC’s updated 2013 GDP growth outlook is closer aligned to the BER and latest consensus forecast of just above 3%. Importantly, even with the softer outlook, the MPC statement highlighted that the risks remain on the downside. We agree.
On the inflation front, despite the threat of higher food and fuel costs, the SARB’s revised headline CPI inflation forecast only showed a marginal deterioration compared to July. Consumer inflation is now expected to average 5.3% in 2012Q4 and 5.2% (slightly up from 5.1% expected in July) during calendar year 2013. Consumer prices are set to remain well behaved and increase by 5% (5.1% previously) during 2014. CPI is therefore projected to remain well within the 3 to 6% inflation target range in 2013 and 2014. As was the case in July, the MPC judges the risks to the inflation outlook as “more or less balanced.”
The SARB’s updated inflation outlook is in line with the views of financial analysts surveyed in the BER’s 2012Q3 inflation expectations survey, which was also released today. After an expected average of 5.5% in 2012, analysts forecast that CPI inflation will average 5.2 and 5.3% respectively during 2013 and 2014. When the views of business people and labour unions are included, the expectations increase to 6 and 6.2% for 2013 and 2014.
Of particular importance is that the SARB’s forecast for core, or underlying, inflation (headline CPI excluding the volatile food, transport and energy components) is also more benign than in July. Core inflation is now forecast to peak at 4.9% in 2012Q4 compared to a high of 5.4% (during 2012Q4 and 2013Q1) expected at the July MPC meeting. Underlying inflation is set to average 4.6% in both 2013 and 2014, down from an 2014 average of 4.8% projected in July.
Food and petrol prices are noted as the main upside risks to the inflation outlook. An important development since the July meeting is that the MPC noted that the current account of the balance of payments has emerged as a risk to the rand exchange rate, and by definition also inflation, outlook. This follows the widening of the deficit to 6.4% of GDP in 2012Q2. The wide shortfall requires significant amounts of foreign capital inflows as financing. The uncertain global environment and potential domestic hurdles (ANC electoral conference in December and possibility of a credit rating downgrade) raise funding risks in the event that the current account shortfall remains large. In our view, these concerns may have been an important driver of the decision not to reduce the repo rate further.
The MPC remains especially concerned about the risks posed to SA by the global economic environment. The final sentence of the statement notes that any future policy action from the SARB will be “highly dependent on global and domestic developments.” The MPC, for example, mentions the impact that the November US presidential elections may have on the US fiscal situation. The MPC seems to have left the door open to a further rate cut(s) in the event that growth in key economies and regions such as the US, Europe and China fail to gain traction. However, the MPC is also aware of potential new risks that may / are already emerging on the inflation front, including the financing of the rising current account deficit.
For now, the BER remains with the view that the repo rate will remain unchanged through the end of 2013. However, our interest rate outlook is based on the assumption that global growth will not continue to deteriorate and that the recent policy actions will over time help to stabilise the environment. If this proves not to be the case, and with the important caveat that the rand does not come under undue pressure in such a scenario, the MPC may cut the repo rate further.