Bottom Line:
- Since the previous report, inflation is showing signs of moderating, and inflation expectations have dipped. Although the SARB will hike again before the end of the year, all indications are that the rate hike cycle is mature and could well come to an end by the end of 2022 or early 2023. After that, interest rates are expected to remain stable and unchanged while the full effects of the hike filter through to the real economy. Eventually, speculation will shift back in favour of rate cuts.
- More rate hikes are anticipated abroad, and the SARB will have to walk a tightrope between protecting the ZAR from volatility and not hiking rates unnecessarily, thereby damaging the economy. SA’s more benign inflation environment compared to inflation environments abroad will need to be considered, but for now, it appears that most of the heavy lifting has been done.
Baseline View:
The SARB will hike again before the end of the year, but it is likely to be the last of the heavy hikes. Heading into 2023, the SARB will likely ease the pace of tightening and may reach for the pause button by Q2 2023. After that, speculation will tilt in favour of rate cuts.
Broad expectations:
Over the past month, rate hike expectations have been pushed back out in response to US data and the weakness in the ZAR. While the market now accords with the near-term expectations on rate hikes, ETM differs from the market in holding a more sanguine outlook where rate hike expectations flatten sooner and turn towards rate cuts before the end of 2023.
Economic responses to rate hikes occur with a lag. That lag can be up to 18m long. As global economic growth slows and central banks start to question whether they have done too much too soon, they will reach for the pause button, and as inflation moderates, the cycle will turn to factor in the timing of rate cuts. That may still take a while to price in, but that is what the ETM expectation reflects. Furthermore, ETM’s inflation risk index shows that the underlying momentum behind domestic inflation has already dissipated considerably and that bias will shift to the downside.
DM Central Banks still in full-blown hiking mode
Much of what is driving SARB decision-making relates to what other central banks are doing. The extent to which other central banks are expected to lift rates will spill over into what the SARB does. The erosion of carry-attractiveness is at the heart of it if the SARB does not respond to the higher offshore interest rates. The danger of doing nothing is that the ZAR comes under considerable pressure and that SA struggles to attract the capital it needs to fund any of its deficits without appropriate adjustment for risk.
In the wake of the latest US inflation data, not much has changed so far as rate hike expectations of the Fed are concerned. The market anticipates that the Fed will lift rates by a further 75bp at the next meeting before moderating the size to 50bp. By early 2023, the Fed will be done hiking and will likely wait to see the effects of all the tightening on the real economy.
This offers readers some perspective on when the pressures on the SARB to continue hiking will dissipate. Given SA’s more moderate inflation cycle, rate cuts may become a theme before the end of 2023.
Rates have deviated significantly from the QPM
Rate hikes have proceeded at a more rapid pace than what the SARB initially anticipated. Much has been driven by developments abroad and the decisions taken by the Fed and other major central banks. The fear of being left behind and creating an environment of currency volatility has not appealed to the SARB, and it has acted with sufficient conservatism to keep such speculation at bay.
Given that the SARB appears to be acting along the lines of the more aggressive tightening schedule, it may achieve its target of neutral interest rates by Q2 2023. If inflation surprises to the downside, that may happen even sooner.
However, it is important to note that the bulk of the heavy lifting is now behind us and that beyond the next meeting, the SARB may moderate the size of its rate hikes. By the end of 2023, the theme will likely be towards interest rate cuts, not just in SA but globally. If the USD were to lose ground in the coming months, the SARB could reach for the pause button even sooner.
International rates surge as central banks vow to contain inflation
Never before has there been such an aggressive and coordinated tightening in global monetary policy. The central banks have recognised that too much stimulation applied to the global economy
through the pandemic has yielded some negative consequences.
Inflation is the most prominent and will have the most severe repercussions for the lower-income population struggling to adjust to negative real wages. It is, therefore, both justified and important that inflation is brought back under control. However, if there is a concern, it is that the central banks are behaving so aggressively that they threaten the labour market with a recession which will see poor income groups swap stress levels about the cost of living to stress about employment and jobs.
The very strong commitment to reducing inflation will eventually bear results, but it will come at the cost of GDP growth. When it does, the commitment to containing inflation will quickly shift to a commitment to support the economy and labour markets. Just as abruptly as the aggressive tightening began, it could reverse.
Inflation is still alarmingly high, but some green shoots of hope that the worst is behind us
Inflation worldwide remains elevated, as the chart below reflects.
However, momentum driving inflation has dissipated considerably, and for the first time, some of the inflation readings have retreated from their highs. Arguably even more encouraging is how inflation expectations have softened and appear to be dropping sharply.
Investors have bought into central bank efforts to reduce inflation and now anticipate that they will succeed. Another factor that will soften their aggressive monetary policy stance.
Inflation risk indicator shows inflationary pressures are turning
ETM has constructed an inflation risk indicator to identify periods of inflationary or disinflationary pressures. The correlation with a lagged 18-month change in the y/y growth is reasonably high and gives one a sense of the “second derivative” or the momentum behind inflation.
Since the last report, the inflation risk index has dipped below the zero bound, indicating that inflationary pressures have morphed from being positive and inflationarty to disinflationary. That implies that through the course of the next few months, that inflation will moderate, and it will be the pace of that moderation that determines whether the SARB can justify hiking alongside the Fed in the way it has so far this year.
The deviation of the red line, which is the y/y growth in the 18m change, from the blue line, the inflation risk index, is unusual and likely to snap back in the year’s remaining months. The SARB will
struggle to continue justifying an aggressive tightening stance while inflation appears to moderate and come back within its 3-6% inflation target range in early 2023.
Fuel price increases are a large component of inflation
Although petrol and diesel inflation is uncomfortably high, they are retreating sharply. That may take a month or two to filter through into overall fuel inflation, but the worst appears to be over. At the very least, the moderation in fuel prices will play a significant role in helping moderate overall inflation. Should the USD lose ground and the ZAR appreciate further against the USD, that would likely drag fuel inflation lower even quicker. The net result is that the pressure on the SARB would ease, which could be a precursor to a softening in the stance of the SARB.
