July MPC: SARB front-loads its rate-hike cycle with an outsized 75bps increase

Posted on by Maria Joubert

Balance of risks table as per MPC statement

Dovish Hawkish
  1. Global economic growth is expected to slow due to rising interest rates, China’s Covid-19 lockdowns and the conflict between Russia and Ukraine.
  2. The SARB projects global GDP to be lower at 3.3% in 2022 (down from 3.5%), 2.5% in 2023 and 2024 (down from 2.7%)
  3. Although local GDP growth has been revised upward for 2022, it has been projected lower for 2023 at 1.3% and 1.5% for 2024 (down from 1.9% for both years)
  4. The impact of the KZN floods and power outages in the country are expected to weigh on economic activity.
  1. QPM model now shows the Repo rate at 5.6% at the end of 2022, up from 5.3%.
  2. Consumer Inflation forecasts have been revised upward to 6.5% by the end of 2022 (up from 5.9%) and 5.7% in 2023 (up from 5.0%).
  3. Economic growth is expected to be higher at 2.0% by the end of 2022, up from 1.7%.
  4. Oil prices are projected to be higher at the end of 2022 at $108/bbl, and $92/bbl in 2023.
  5. Risks to the inflation outlook remain to the topside due to the rise in food prices and high oil prices. Food inflation is projected to reach 7.4% in 2022 (up from 6.6%) and 6.2% in 2023 (up from 5.6%).
  6. The yield curve for ZAR-denominated bonds remains steep.
  7. South Africa’s current account is expected to fall to 2.0% of GDP in 2022, 0.4% in 2023, and a deficit of 0.4% in 2024.
  8. The normalisation of monetary policy in developed economies continues.

The ZAR is projected to reach R16.1000/$ by the end of 2022 compared to R15.8800/$ in the previous meeting.

Implications for SA markets

FRA:

It has been a volatile day of trade for rate markets as markets react to the larger-than-expected rate hikes by the ECB and SARB. As expected, the SARB’s 75bps hike has resulted in a flattening in the FRA curve post the meeting as traders priced for a front-loaded rate hiking cycle. While the FRA market is paying shorter-dated tenors higher, the total rate hike risk priced into the market for the next 18 months remains largely unchanged. This clearly indicates that the market is pricing for a heavily front-loaded hiking cycle. With inflation expected to pull back sharply in 2023 as the high base effects and impact of tighter monetary conditions take hold, we expect the flattening bias to persist going forward.

IRS

Given the nature of the decision, it was not surprising to see some flattening pressure emerge along the swap curve. The front-loading of interest rate hikes emboldened payers at the short end as the market is still pricing in sustained inflation and a steeper rate hike trajectory in the coming months. The receiver interest seen for longer-dated swaps shows the market responding to the longer-term impact of the depth of SARB’s rate hiking cycle, heightening recessionary fears as the global economy is deemed to slow in H2 of the year. In terms of the shape of the curve, the 2v10 swap spread has, therefore, compressed with the curve near its flattest over the past two months. Our view given the new expected rate trajectory remains towards a further flattening of the IRS curve in the near term given the front-loading of rate hike risk and the associated longer-term economic risks. Therefore, receiving at current rates through the belly to long end of the curve remains prudent.

Bonds

Following the SARB’s interest rate hike announcement, the SAGB curve has bull flattened. The SARB has front-loaded its hiking cycle, likely easing some concerns about high inflation in the coming months and years. Adding to this, we have also seen some flattening in core bonds after the ECB hiked interest rates by 50bps. In the short term, the rate hikes that we have seen today and the potential for further hikes could lead to the curve flattening. Another factor that may lead to further flattening is the increased risk of a global recession.

ZAR

Heading into today’s SARB policy announcement, the USD-ZAR struggled for direction, with the pair consolidating near the previous close. Following the announcement, which came amidst a pullback in the USD, the ZAR is trading on the front foot, with the USD-ZAR testing levels around the 17.00 mark. While the bold rate hike will bolster SA’s carry appeal, the ZAR still faces a number of headwinds, including ongoing loadshedding, falling commodity prices and a strong dollar.

Bottom Line

The SARB surprised with a 75bp rate hike, affirming its commitment to reining in inflation and inflation expectations. The MPC’s voting pattern was very interesting, with three members voting for a 75bp hike, one for a 50bp hike, and, surprisingly, one member voted for a 100bp move. The outsized hike comes as a result of persistently high price pressures and recent currency depreciation. Moreover, it indicates that the SARB is committed to front-loading its hiking cycle and that price stability remains its main priority.

 

Analysis

  • The inflation forecasts generated by the Quarterly Projection Model (QPM) were revised higher since the last policy meeting in May, with the SARB expecting headline inflation to average 6.5% through 2022, compared to 5.9% previously. As for 2023 and 2024, the model predicts CPI growth of 5.7% (5.0% previously) and 4.7% (unchanged), respectively, pointing to a very gradual slowdown towards the midpoint of the target range.
  • Moreover, the SARB’s core inflation forecasts, which better reflect demand-side price pressures, were revised higher from 3.9% to 4.3% for 2022 and from 4.9% to 5.6% for 2023, while the 2024 forecast also rose marginally from 4.8% to 4.9%.
  • The private sector has also clearly taken note of a higher inflation outlook, with the BER inflation survey, as well as market inflation expectations, pointing to an increase in future price growth. This primarily reflects a weaker exchange rate and rising domestic and global inflationary pressures, in particular relating to fuel and food prices.
  • Governor Kganyago said that risks to the overall inflation outlook are assessed to be tilted to the upside at present, primarily owing to global fuel, producer price, and food inflation that may continue to surprise higher going forward. Note, however, that although ETM’s inflation risk index remains elevated, it is not yet pointing to any risk of runaway inflation in SA.

  • Interestingly, the SARB increased its GDP growth forecast for 2022 from 1.7% to 2.0%, even though it expects a 1.1% contraction in the second quarter. Further out, however, the economic outlook is concerningly weak, with a 1.3% growth rate expected in 2023, and a 1.5% growth rate forecast for 2024. The SARB also assessed the risks to its medium-term growth outlook to be tilted to the downside, suggesting the economy may be heading back to the sub-2% lull that it was stuck in for years before the post-pandemic recovery.
  • On the international front, the propensity for a global growth slowdown has increased amid a withdrawal of policy stimulus, persistent supply-side constraints, and China’s Covid-19 lockdowns. Accordingly, the SARB revised its 2022 global growth forecast down from 3.5% to 3.3%, and its 2023 and 2024 forecasts to 2.5% from 2.7%.

 

Going Forward

  • The 75bp rate hike and more aggressive tightening outlook will go a long way in signalling the SARB’s steadfast commitment to bringing inflation down, economic growth risks notwithstanding. The SARB noted that it would recalibrate policy based on incoming data as needed through the months ahead, but for now, there are few signs of inflationary pressures moderating anytime soon.
  • On the whole, the SARB’s commitment to fighting inflation will continue to support the ZAR’s resilience against a backdrop of tightening financing conditions across the globe. The ZAR remains undervalued against the USD, and with good reason, but the SARB’s hawkish resolve will stand the local unit in good stead until signs emerge that global stagflationary pressures may begin to ease.

Conclusion

The SARB’s 75bp rate hike and policy outlook suggested that the MPC is front-loading its rate-hike cycle, with the move taking the benchmark interest rate close to what the QPM predicts it to be at year-end despite there still being two more meetings left. This will prevent the SARB from falling behind the curve as other central banks turn more hawkish, and help avoid a further ZAR blowout.