January MPC: SARB scales back on its tightening as growth concerns intensify

Posted on by Maria Joubert

Balance of risks table as per MPC statement

Dovish Hawkish
  1. Expectations that global financial assets will remain volatile.
  2. Current account balance expected to come in at a deficit of 0.7% of GDP for 2022.
  3. Global price pressures continue to spread from goods to services and wages.
  4. Local electricity price inflation estimate has been revised higher.
  5. Local food price inflation forecast was revised up.
  6. Risks to the inflation outlook assessed to the upside.
  7. Tightened global financial conditions have raised the risk profiles of economies needing foreign capital.
  8. Inflation expectations have increased recently, with 2023’s above the SARB’s target range.
  9. SARB sees headline inflation above 4.5% until Q4 2024
  1. The global growth outlook has weakened.
  2. The SARB forecasts no growth for SA in Q4 of last year and only 0.3% for this year as a whole.
  3. 2024’s growth forecast revised lower to just 0.7%, from 1.4% previously.
  4. Output gap expected at near zero, implying little impact on inflation.
  5. Fuel price inflation forecast at -2.7% for 2023.
  6. Core inflation forecast lowered for 2023 to 5.2% from 5.5% estimated previously.
  7. QPM implies that the Repo Rate will average 7.08% in Q4 this year.

Implications for SA markets

FRA
As with swaps, FRAs were received lower post the announcement with the curve bull steepening. Although the inflation outlook is still assessed to the upside in the near term, the risk of another rate hike is decreasing and the market is starting to price this in. As such, we expect FRAs to remain attractive for receivers over the near term as they will gradually need to shift lower in the middle to longer dates to price in the prospect of rate cuts. The inflation cycle has turned, and the interest rate cycle will follow, especially given the lagged effects of the rate hikes and persistent load-shedding on the economy.

 

IRS
Swaps have unsurprisingly been received lower post the MPC announcement, with the curve bull steepening as some rate hike risk is being priced out. With global and domestic inflation having peaked, and as expectations of a less aggressive Federal Reserve continue to build, we could see receiver interest continue along the IRS curve in the coming months. The 2v10 swap spread has widened as the curve has bull steepened, with this expected to persist unless we get some topside
surprises in the next few CPI releases.

 

Bonds
Leading into the SARB policy announcement, SAGB yields rose as the market positioned for a relatively more aggressive rate hike than was delivered. However, as the market digested the 25bp hike and dovish-leaning economic forecasts, the curve dropped sharply. The rates-sensitive 4-year bond shed as much as 8bps from its yield before the session’s end, reflecting how the market reduced bets on further tightening. Looking ahead, the focus will gradually begin to shift to fiscal matters ahead of the budget speech in February, while investors will also be keeping an eye out for a continued shift in the global monetary policy tide.

 

ZAR
The ZAR pared its initial gains for the day after the SARB announced its 25bps hike, suggesting that market participants had priced in a strong chance of a 50bp rate hike. The currency was pressured by the downward revisions to growth and as it appears that this could potentially be the final rate hike in the cycle. This doesn’t, however, alter our fundamental view that the ZAR will appreciate significantly through the year ahead. Although the rate hike marked a turning point in the SARB’s tightening path, the interest rate differential between the US and SA remains supportive and the US dollar’s overvaluation remains.

Bottom Line

Playing it cautiously and taking into consideration South Africa’s deteriorating growth outlook, the MPC favoured a 25bps hike today, taking the benchmark Repo Rate to 7.25%, in a 3-2 decision. We expect that today’s rate hike is likely the second last one in the current hiking cycle, with policymakers expected to sit back after March and wait for the tight lending conditions to take effect. The high base effects from last year are expected to take hold from March onwards, which should result in a marked deceleration in headline inflation going forward.

Analysis

 

  • Given the SARB’s downward revision to its growth outlook, the move to downscale the pace of tightening doesn’t come as a surprise. The SARB slashed its 2023 GDP growth forecast from 1.1% in November to 0.3% and its 2024 and 2025 projections from 1.4% and 1.5% to 0.7% and 1.0%, respectively.
  • The SARB said that the unprecedented level of loadshedding is estimated to deduct as much as 2 percentage points from growth in 2023 (0.6ppts previously). The SARB also highlighted that declining commodity prices are expected to lead to less robust exports, one of the main
    drivers of growth in 2022.
  • Not all is doom and gloom on the growth front. The SARB said that a material reduction in load-shedding would provide a significant boost to growth. While it is unlikely that load-shedding will decrease markedly in the near term, there have been some encouraging developments in terms of resolving SA’s energy crisis in recent weeks.
  • That said, we still expect SA’s economy to run well below its potential over the next 12-24 months, even as businesses become more resilient to the ongoing load-shedding.
  • On the inflation front, the SARB left its 2023 headline CPI forecast unchanged at 5.4%. The 2024 inflation forecast meanwhile was revised higher to 4.8% (4.5% previously), while the 2025 projection remained steady at 4.5%. Core inflation, which policymakers and traders continue to monitor closely, is expected to average 5.2% in 2023, 4.7% in 2024 and 4.5% in 2025.

  • While we expect the high base effects of 2022 to result in a meaningful deceleration in inflation from March onwards, inflation risks are still assessed to be to the upside. Arguably the most notable upside risk to the inflation outlook is electricity prices. Speaking of which, the SARB revised its local electricity price inflation forecast higher to 12.9% in 2023, 14.5% in 2024 and 10.9% in 2025.
  • On the contrary, food and fuel price inflation is expected to have peaked. Although global food and fuel price inflation have eased due to the impact of a weaker rand, the SARB upwardly revised its food price inflation projection to 7.3% (6.2% previously) for 2023 and 4.4% (4.2% previously) for 2024. While the SARB raised its food price inflation forecast, it must be noted that the revised forecast is notably lower than the 2022 reading of 9.2%.

Going forward

 

  • The SARB’s decision to deliver a smaller 25bps is a sign that it is concerned about the deteriorating growth outlook amid the worsening energy crisis. That said, the fact that 2 out of the 5 MPC members voted for a 50bps hike shows that the SARB is not yet comfortable that inflation and inflation expectations are under control.
  • As stated in recent communication, our base case is for the SARB to conclude its rate tightening cycle in March with one final 25bps hike. That said, a lot can happen between now and then. We have two CPI readings and the FOMC decision next week, which could lead to the SARB potentially leaving rates on hold in March should we see a further significant deceleration in local inflation or dovish guidance from the Fed.

As always, the ZAR will play a significant role in terms of inflation in the months ahead. While the ZAR has had a turbulent start to the year, ETM’s proprietary currency models still point to currency strength in the months ahead, primarily due to a weakening USD. ETM is of the view that we could see the USD-ZAR fall to low 16.00s in the months ahead, which would provide some much-welcomed relief for importers and consumers.