November MPC: SARB sticks to 75bp but hikes should slow going forward

Balance of risks table as per MPC statement

Dovish

Hawkish

The global growth outlook has deteriorated. As such, the SARB downwardly revised its 2023 growth forecasts to 1.9% (from 2.0%)
SA’s growth projections were revised down to 1.8% (from 1.9%) for 2022. SA’s economy is expected to expand by just 1.1% in 2023 and 1.4% in 2024.
Load shedding continues to dampen SA’s growth outlook and is expected to detract 0.6% of GDP next year.
The easing of global oil prices has contributed to a less aggressive rise in fuel price inflation for this year, at 33.3%, down from 33.5%. Fuel price inflation is expected to moderate in 2023, averaging 0.8% (down from 1.1%).

The SARB has upwardly revised its headline inflation figures for 2022 and 2023 to 6.7% (up from 6.5%) and 5.4% (up from 5.3%).
Risks to the inflation outlook are skewed to the upside, given a weaker rand and electricity price increases. Food inflation is expected at 6.2% this year (from 5.5%).
Although fiscal risk has eased on the back of better tax revenue, financing conditions remain tight, and the yield curve remains steep.
SARB expects that the financial market environment will remain volatile.
The SARB continued to note that global policy normalisation remains high, especially for major markets.

Implications for SA markets

FRA	Traders were paying FRAs in the lead-up to the SARB meeting as they have fully backed in a 75bps rate hike following the surprise CPI increase for October. A flattening bias is now evident further along the FRA curve as longer-term inflation expectations moderate alongside the expected slowing of economic growth, which will help inflation to ease next year. The professional market is pricing in another rate hike in January, although only of 25bp. Beyond January, we expect the SARB to pause its rate hikes and wait for the impact of this year’s increases to filter through. Therefore, longer-dated FRAs remain attractive for receivers at the current levels.
IRS	Swaps were received post the MPC announcement, suggesting that rate hike expectations have now reached their peak. We expect this trend to continue as we have seen global inflation likely peak, and the Fed has changed its stance in terms of aggressive rate hikes going forward. Looking at the 2v10 spread, the narrowing seen in recent sessions has continued, with the spread heading to its lowest since the start of the pandemic. We expect the receiver bias along the curve to continue with the bias for more flattening, as inflation risks are still skewed to the upside in the short term and concerns about deteriorating longer-term growth dynamics have been rising.
Bonds	Post the SARB announcement, SAGBs have remained bid. While yields are broadly lower across the curve, more pronounced movements were observed at the long end of the curve. Therefore, the curve continued to bull flatten. The upward revision to the inflation forecast has capped front-end yields, while a weaker growth outlook has supported tenors at the long end. In the near-to-medium term, we should see this flattening bias persist as growth risks and improved fiscal metrics will be supportive of longer-dated bonds.
ZAR	The ZAR’s immediate reaction to the SARB’s policy update was fairly muted, suggesting that the market was fully priced for the 75bp rate hike that was announced. Specifically, the ZAR consolidated just north of the R17.0000/$ handle after depreciating to that level in the run-up to the policy update. This suggests that anything less than a 75bp hike would have led to further ZAR weakness on the day, with the SARB, by and large, expected to follow in the Fed’s footsteps at a minimum. However, in the longer run, the 75bp rate hike may turn out to be very ZAR-supportive if the Fed slows its rate-hike cycle into the end of the year, with SA’s rate differential and carry attractiveness boosted by today’s outsized rate hike.

Bottom Line

In line with expectations, the SARB increased the Repo Rate by 75bps to 7.00%. Three members of the committee were in favour of the 75bp hike, while the other two members preferred a smaller 50bp increase. This compares to the September meeting, where two members voted for a 100bp increase. The voting pattern suggests that the SARB is likely to ease off its rate hikes in early 2023 with growth concerns mounting and as the global monetary policy direction shifts.

Analysis

The SARB had quite a tightrope to walk at the last MPC meeting of the year, balancing inflation risks with expectations that growth will slow materially in the coming months.
The SARB noted that medium-term inflation risks remain to the topside. The forecast for core inflation was unchanged at 4.3% for 2022, higher than previously expected, and at 5.5% (from 5.4%) for 2023. ETM’s view is that these forecasts are a bit excessive, as a slowing economy and the lagged impact of this year’s rate hikes will dent demand and drag core inflation lower.
Headline inflation, meanwhile, faces downside risks from easing food and fuel prices. Base effects mean that y/y price growth in food and fuel items next year will likely be negative given the elevated levels we saw this year and the impact of weaker demand in 2023 owing to slowing global growth. ETM’s inflation risk index shows that underlying momentum behind inflation has turned negative, pointing to disinflation. Typically, this is synonymous with softening inflation in the months that follow.

There are still some upside risks, however, coming from ongoing wage negotiations, while electricity and other administrated prices are set to rise further. These increases, however, will lead to lower discretionary spending, which will have disinflationary effects on several goods and services categories.
Near-term inflation expectations remain elevated but are moderating quickly when looking at a longer-term horizon. As the impact of this year’s monetary policy tightening begins to filter through, we should see near-term inflation expectations also begin to moderate.
The growth outlook, meanwhile, is looking a lot darker than when compared to the last MPC meeting. The SARB currently forecasts growth for Q4 at just 0.1%, mostly as a result of loadshedding. The projections for next year and 2024 were also lowered. The economy is now only expected to expand by 1.1% next year, well below the 1.9% estimated at the last MPC meeting.

This suggests that SA’s output gap is set to widen through the months ahead. The theoretical negative output gap should be disinflationary in nature and will contribute to weaker price growth through 2023. The SARB expects that the output gap will close by Q3 of 2023. We see downside risks to this view, with the negative output gap likely to last into 2024. Local factors remain massively detrimental to growth going forward, while global growth may slow even more than currently forecast, given the aggressiveness of central bank policy tightening and a shift to more austere fiscal policies amid surging debt-servicing costs worldwide.
Governor Kganyago often cited the tightening of monetary policy abroad and its impact on the local economy. We expect that the Federal Reserve and other major central banks will not be able to hike rates as aggressively as they currently suggest, which will take pressure off the SARB to keep hiking in the months ahead. A shift from the Fed is looking likely as early as next month.

Going forward

The SARB’s decision to deliver an outsized rate hike today means that most of the hiking is now behind us. ETM expects the SARB to deliver one or possibly two more rate hikes of a smaller magnitude (25bps) in the first quarter of 2023, taking the Repo Rate to a peak of 7.25% or 7.50% in the current cycle.
With growth risks intensifying and the ZAR expected to stage a meaningful recovery in the first half of next year against the backdrop of a pivot in global monetary policy, we expect rates to begin to fall in the second half of next year. This notion is underpinned by the SARB’s forecast for the Repo rate to average 6.55% in the final quarter of 2023.