Monetary policy

 2016-05-21 08:07 AM by

MPC on hold for now

Salient points

  • The MPC left the repo rate unchanged at 7.0% at the May MPC meeting following a total of 75bps in Q1 16. Five of the MPC members preferred rates to be on hold whereas one member preferred a hike of 25bps.
  • The decision was in line with market expectations towards the end of last week although the probability of a rate hike increased to 50% following the selloff in the ZAR this week. The Reserve Bank’s decision was based on its analysis prior to the ZAR selloff this week. The inflation forecast presented to the MPC has assumed a stronger rand than the current level which implies downside risks to the forecast. The rand remains vulnerable to domestic political developments and the risks of an earlier US rate hike.
  • The MPC warned again of the dilemma it faced of upside risks to the inflation forecast and a worsening growth outlook. 

Inflation risks – to the upside. Slight improvement in the medium term inflation trajectory but this could again change if the depreciation of the ZAR persists in coming months.

  • The Reserve Bank’s inflation forecast presented at the May MPC meeting was marginally better than the forecast at the March MPC meeting. It showed that CPI inflation could stay outside of the target band until mid-2017 where after it could return within the target band.
  • Some of the assumptions were revised lower. For example, the increase in electricity tariffs for 2017 was revised down from 9.5% to 8.5% and the output gap wider. Moreover, the higher level of interest rates over the forecast period (out to 2018) is also seen as curtailing inflation.
  • However, it assumed a somewhat stronger rand exchange rate in its forecast. The sharp selloff in the ZAR this week has not been factored into the forecast.
  • The improvement arising from the above was countered by an acceleration in food prices (April’s food price inflation rate climbed to 11.3% and is forecast to rise to around 12% in Q4 16). The oil price forecast for end 2017 has been raised from $45 per barrel to $52 per barrel. The oil price is currently trading at $47. 56 per barrel.
  • CPI inflation is forecast to rise by an average rate of 6.8% (6.6% previously) in Q3 16 and peak at 7.3% in Q4 16. It could then return within the target band in Q3 17 (5.8%) compared with Q1 17 previously. This is in line with our forecast. The core CPI inflation forecast has been revised lower for Q2 16 and Q3 16 owing mainly to the lower outcome of March’s CPI inflation reading as tertiary education fees were unchanged. However, it is forecast to breach the upper end of the target band from Q3-16 to Q2-17.
  • The Reserve Bank will gain more insight into inflation expectations when the BER publishes its quarterly inflation survey in July. It noted that breakeven inflation expectations were more or less unchanged since the March MPC meeting. Again, this has not incorporated this week’s upward movement in bond yield. The yield on the R186 increased 25bps to 9.43%.The 10 year inflation breakeven inflation rate increased to 7.7% today compared with 7.5% at the March MPC meeting reflecting the increase in the political risk premium arising from unresolved political issues. .
  • With regards to wage growth and the pass from the weaker exchange rate, it noted that wage growth appears to be moderating and that the latter remains relatively subdued. Slower wage growth has been evident in the private sector and nominal remuneration per worker in the formal sector (excluding the agriculture) has moderated to less than 6.0% in Q4 15. There are indications that the pass through from the weaker ZAR is rising (e.g. Car prices).

Growth – downside risks remain. Growth outlook for 2016 revised lower

  • The GDP growth forecast for 2016 was revised down from 0.6% from 0.8% although it was left unchanged at 1.4% and 1.8% for 2017 and 2018 respectively. The deterioration in the forecast for 2016 was caused by a very weak growth in Q1 16 owing to a deep decline in mining production, as well as declines in electricity production and consumption. The Reserve Bank stated that its forecast for GDP growth in Q1 16 is barely positive but it also sees this as the low point of the forecast.

Event risk in June

  •  The decision to pause at this month’s meeting can mainly be ascribed to the medium term inflation forecast that has improved slightly and frontloaded rate hikes in Q1 16. However, the outlook for the ZAR in the run-up to the July MPC meeting will be important and there are significant event risks to monitor.
    • S&P is scheduled to publish its ratings review on June 3. In addition to the impact of
    • FOMC meeting on June 15.
    • GDP growth data on June 8: Economic data releases will include the publication of GDP uncertainty on confidence and growth, developments at SOE’s will also be monitored. growth for Q1 16 on June 8. In addition to StatSA’s publication of growth in the production side of the economy, it will also publish expenditure data for the first time. Reserve Bank’s data will be revised back to 2010.
      • Over the past few years, the residual (which is the gap between production and expenditure sides of the economy has been growing. It is highly possible that real expenditure data (as opposed to production) will be revised. This could see could see changes in consumer spending, inventories and imports in constant prices.