MPC preview: Rate cut justified … but taking no action would be prudent
DURBAN – The South African Reserve Bank (SARB) Monetary Policy Committee (MPC) is currently engaged in its first semi-monthly meeting of 2020.
At its previous meeting (in November 2019), the MPC opened the door for an interest rate cut this year. The implied path of interest rates – as generated by the central bank’s Quarterly Projection Model - indicated scope for one 25 basis points cut in the repo rate towards the third quarter of 2020. The past two months have seen several developments and data releases that support an interest rate cut sooner rather than later.
The MPC said in November it expects inflation to average 4.1 percent in 2019Q4. This mean is now more likely to come in around 3.8 percent after Statistics South Africa (StatsSA) measured inflation of 3.7 percent year on year and 3.6 percent year on year in October and November 2019, respectively. There will certainly be some base effects on inflation readings during 2020H1 due to the strong disinflationary trend seen early last year. Nonetheless, an ongoing trend of below-expectation inflation numbers suggests that the SARB’s above-5 percent inflation forecasts for each of the four quarters in 2020 could be too lofty. Lower inflation forecasts widen the door for a rate cut.
Opening the door for a rate cut
There is already some appetite within the MPC for lowering interest rates. The vote at their November meeting was split between two policymakers favouring a rate cut and three preferring no action. (If there were six MPC members - like during 2015-2017 and again in 2019Q1 – a tie-break decision by the governor could possibly have resulted in a cut.) A two-three split can easily be a prelude to a cut at the next meeting: a similar split in May 2019 was followed by a repo rate cut (by unanimous decision) at the next MPC meeting in July of that year.
Stronger rand supporting low retail inflation
Policymakers will find comfort in a recently stronger rand. The South African currency reached a five-month high late in December, breaking below the R15.00/$ level. (Admittedly, the rand always trades strong in the last two weeks of December as imports slow.) The current reading around R14.50/$ is better than the R14.94/$ that the SARB used for its inflation forecasts in November 2019. Resilience in the rand has been an important contributor to low inflation: Stats SA measured a 13.2 percent y-o-y decline in the cost of imported goods during October 2019 (latest available data).
This imported deflation contributed to retail inflation declining to just 2.9 percent y-o-y in October (latest available data), according to Stats SA. Another reason behind low retail inflation is the inability of retailers to pass on price increases to consumers. In their latest annual reports, retailers have cited low economic growth, consumers grappling with household debt, escalating livings costs and high levels of unemployment as the reasons behind this. Unsurprisingly, according to the Bureau for Economic Research (BER), retail sector confidence declined to a 20-year low in 2019Q3.
It is highly unlikely that the SARB would risk stirring higher inflation if with a cut to the repo rate in 2020. Calculations by analysts at Economists.co.za indicate that demand-side inflation – i.e. price changes on goods and services that consumers can make choices on – was below zero. The cost of these ‘choice goods’ (accounting for three-quarters of the inflation basket) declined by 0.7% y-o-y near the end of 2019. In other words, where consumers have a choice between suppliers and can influence pricing by shifting their demand, there has been slight price deflation. In contrast, ‘necessity goods’ – including healthcare and medical insurance, fuel, home security and school fees – increased by a significant 8.4 percent y-o-y.
Weak economic growth persists
Local media recently reported on the World Bank cutting its growth outlook for South Africa to just 0.9 percent for 2020. Available forecasts collated by Focus Economics point to a median projection for real GDP growth to reach just over 1 percent in 2020 – highly dependent on the frequency of loadshedding, of course – from around 0.5 percent last year. Manufacturing production is expected to rise by 0.7 percent after a decline of 0.4 percent in 2019. An improvement in economic growth this year is also predicated on an expectation that fixed investment spending will increase in 2020 following a pullback in investment during 2018-2019.
Economic growth around 1 percent will certainly not be too bad a performance given the country’s recent economic trend. However, it is unlikely that economic expansion will reach the projected population growth rate of 1.3 percent This will result in a sixth straight year of declining real GDP per capita. Only a half-dozen other countries are expected to see a six-year stretch in negative real GDP per capita changes during 2015-2020: Venezuela, Equatorial Guinea, Angola, Burundi, Liberia and Nigeria.
Would wait-and-see be more prudent?
While the above helps to justify a rate cut this month, the MPC might take a more prudent view and hold off any action until its next meeting in March – or even May. The coming two months have a very full data calendar for the SARB to consider. These include the 2020 budget speech (third week of February), GDP data for 2019Q4 (first week of March), a decision by the National Energy Regulator of South Africa (Nersa) on Eskom’s tariff increases this year (by mid-March), and Moody’s Investors Service’s next review (March 27).
These events will have a direct impact on the SARB’s projections for inflation, economic growth and fiscal dynamics. The MPC cannot afford to get its assumptions wrong on these factors and would certainly be justified in holding off any monetary policy action until more is known on these factors. Policymakers can also not afford to ignore the country’s economic crisis – low growth and rising unemployment. The SARB has repeatedly said that it does not see monetary policy action as a solution to growth challenges. But in a low-inflation environment, interest rate cuts will certainly do no harm.
Article by Lullu Krugel, Chief Economist PwC Strategy& and Dr Christie Viljoen, PwC Strategy& Economist.