WE CONTINUE to expect no change in the repo rate for the remainder of the year as consumer price index (CPI) inflation falls, but the Reserve Bank’s stance is hawkish.
The Reserve Bank has frequently reiterated this year that the domestic interest rate cycle will follow a gradual upward trajectory. On the basis of this communication, interest rates should be left unchanged at the monetary policy committee (MPC) meeting from today until Thursday, as the repo rate was hiked by 25 basis points at the previous meeting in July.
We expect the repo rate will remain at 5.75 percent this month, as well as at the November MPC meeting, which will be the last one this year. Also supporting our view for interest rates to remain unchanged this year is the fact that CPI inflation has started to fall since the July meeting, food price inflation is falling on lower maize prices and is expected to continue to do so, the petrol price has fallen (and is in line to fall further) and producer price index (PPI) inflation is declining.
The bank targets CPI inflation between 3 percent and 6 percent year on year in the six to 24-month (future) period in its monetary policy decisions. The lower CPI inflation ends the year, the lower it will start next year and so declining CPI inflation in the second half of this year will lower the bank’s inflation expectations for next year, reducing pressure for higher interest rates from this source. We continue to believe the central bank will lower its forecast for average CPI inflation to 6.2 percent year on year for 2014, and to 5.7 percent year on year for 2015.
On the currency front, the nominal trade-weighted rand dipped to a reading of only 2 percent weaker on the year toward the end of August, compared with July 15 (the start of that month’s MPC meeting) when it was 9 percent weaker year on year. The rand has strengthened against the euro and the British pound to R14.23 to the euro and R17.86 to the pound at 5pm yesterday from R14.52 a euro and R18.35 a pound on July 15, as both the EU and UK currencies weakened.
Against the dollar, however, the rand has weakened significantly since the last MPC meeting from R10.70 a dollar to about R11, but this has been essentially because of dollar strength and not significant rand weakness. Counteracting the impact on the rand oil price of dollar strength, is the fact that the price of Brent crude oil has fallen to $97 a barrel from closer to $106 a barrel. In rand terms, the oil price has fallen to R1 072 a barrel from R1 130.
The British pound has weakened on concerns that Scotland may choose independence. Up until the end of last month markets expected Scotland would not seek to dissolve its tri-century union with England, Northern Ireland and Wales. However, recent polls have indicated the possibility of a yes vote. Even the growing expectation that the UK will hike interest rates next year have failed to see sterling recover. A weaker pound will assist in reducing inflation imported into South Africa, as will a weaker euro.
The European Central Bank (ECB) marginally cut interest rates at its most recent governing council meeting, with the main refinancing rate falling from 0.15 percent to 0.05 percent, the marginal lending facility from 0.4 percent to 0.3 percent and the deposit facility rate from minus 0.1 percent to minus 0.2 percent. The euro zone is at risk of falling into recession again, as well as at significant risk of deflation. Additionally, the euro area is engaging in the purchase of non-financial private sector assets.
Faster growth in the region could be better spurred by some loosening in fiscal policy, particularly in Germany, which will stimulate demand in the region. Such an improvement in economic growth would be a better driver to combat deflation.
Euro zone communication and movement towards quantitative easing has seen the yield on the 10-year US treasury drop since the start of the year, despite increased communication from the Federal Reserve that US interest rates will probably begin rising next year. South Africa’s 10-year government bond has also eased.
The latest monetary policy communication from the ECB is consequently supportive of the Reserve Bank leaving interest rates unchanged in September and November. Besides the weakness of the euro and pound, the dollar has strengthened as growth in the US has exceeded that of other developed economies, leading to expectations that it will hike interest rates next year, potentially as early as June. With previous expectations for US interest rate “lift-off” being September 2015, the quickening of the timing of the first interest rate hike since 2006 has improved appetite to hold dollars and so increased purchases.
Japan has also stated that it will loosen monetary policy further or take other measures to meet its inflation target.
On a relative basis, by cutting its interest rates, the euro area has made the US-euro carry trade more attractive. The dollar’s strength has assisted in pushing the rand over R11/dollar, although the rand also saw some weakness on the publication of the wider-than-expected current account deficit for the second quarter.
On the domestic inflation front, CPI inflation climbed from 5.3 percent year on year in November last year, to 6.6 percent by the middle of this year, prompting the Reserve Bank to raise interest rates by 75 basis points. However, we believe that after rising in the first half, CPI inflation will fall for the remainder of the year on declining food price inflation, reducing the need for further interest rate hikes in 2014.
South Africa has recently seen a sharp drop in its inflation rate on agricultural product prices, from the heady 13.3 percent year on year reached in March, to 4.4 percent year on year in June. The sharp run-up in the agricultural products inflation rate in the early part of the year was due chiefly to the rapid escalation in grain prices due to poor domestic weather conditions and rand weakness. An inflation rate of 27.6 percent for cereals and other crops was recorded in February last year.
Maize is the key feed input into meat, dairy and egg prices, and lower maize prices are positive for the heavily weighted meat category in the CPI. The bank has recently highlighted the ascent in wheat prices, and may see the descent in the maize price balanced by the increase in the wheat price. However, the downward effect of maize prices on the CPI, due to its wider impact, is likely to outweigh upward price pressure from wheat.
We continue to believe CPI inflation will fall further this year and re-enter the inflation target, both of which significantly reduce the need to hike interest rates again this year, particularly given the weakness of economic growth.
Annabel Bishop is Investec’s chief economist. The Reserve Bank’s monetary policy committee will issue its decision on interest rates on Thursday.