Repo rate flat as GDP and CPI are revised lower

Gill Marcus’s last MPC meeting

At their previous meeting the MPC voted 6 to 1 to raise rates whereas at this meeting they voted 6 to 1 to keep rates unchanged, indicating how uncertain the monetary policy environment is. Growth was revised lower with risks remaining to the downside. Inflation was also revised lower, due to lower expected food and petrol prices, but with risks seen to be to the upside due to the vulnerability of the exchange rate. Although the outlook for core remained unchanged, we think the decision to keep the repo rate at 5.75% was primarily based on their revised forecasts for headline inflation.

Importantly, for the first time, the SARB referred to tighter financial conditions arising from the increased cost of bank funding. As we have highlighted recently to clients, bank funding, and especially term funding rates, have increased, and are at historical highs (figs 4 & 5) due to the effect of banks gearing up to meet Basel III qualifying criteria for the new LCR (liquidity coverage ratio). This trend has been exacerbated by the change in relative pricing of wholesale (longer duration) versus retail funding post the collapse of African Bank. The increase in term funding rates has tightened financial conditions over and above tightening related to hikes in the repo rate. We expect this structural change in bank funding will have an increasing influence over monetary policy in the years ahead.

The SARB expects headline CPI inflation to average 6.2% in 2014, falling to 5.7% in 2015 and 5.8% in 2016, as opposed to their forecast in July of 6.3%, 5.9% and 5.6% in the respective years. The 2016 forecast for inflation has been raised as a result of higher electricity tariffs.

The change in the SARB’s outlook for inflation is significant in that they no longer expect inflation to peak in Q4:14, and estimate that the peak has already happened, in Q2:14 at 6.5%y/y. In addition the length of time that the SARB expects inflation to remain outside of the target band has shortened - they expect it will fall below 6.0% in Q1:15 as opposed to in Q2:15. This is in line with our forecasts. We think these changes are probably quite a relief to the market, since most economists found it difficult to calibrate their models to mimic the SARB’s expectations. After yesterday’s surprise increase from 9.0%y/y to 9.5%y/y, it is also comforting that the SARB anticipates food inflation will fall over coming months. The SARB highlighted that declining global food, oil and other commodity prices will assist domestic inflation in absorbing a weaker currency.

Growth was also revised lower, from 1.7%, 2.9% and 3.2%y/y in 2014, 2015 and 2016 respectively to 1.5%, 2.8% and 3.1%. We still think GDP for 2015 and 2016 will continue to disappoint to the downside.

The SARB flagged risks relating to financing of the current account deficit (CAD), indicating that they anticipate it will become increasingly challenging. Although they state that they expect the CAD to narrow gradually over time, their outlook for the trade balance seemed quite sombre and they do not expect export growth to recover until Q4. Wage inflation was also raised as an impediment to a narrower CAD.

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