Balance of risks as per MPC statement
Dovish:
- Global growth forecast revised lower to 3.7% (4.4% previously) for 2022 and 2.8% (3.3%) for 2023.
- Weak investment in the government sector weighing on growth.
- Commodity prices are expected to correct lower in 2023.
- Strong terms of trade have appreciated the ZAR and helped damped price pressures.
- Electricity price inflation revised down to 11.0% for 2022 (from 14.5%) and to 9.2% in 2023 (from 12.4%).
Hawkish:
- Inflation estimates were generally revised higher, with the SARB seeing CPI at 5.8% for 2022 compared to the prior estimate of 4.9%.
- Core inflation estimates also revised higher, penciling it in for 4.2% for this year, up from the previous estimate of 3.8%.
- Risks to the inflation outlook are skewed to the topside, with it likely to break above the target range in Q2.
- The oil price assumption was revised dramatically higher to $103 per barrel for 2022, up from $78 per barrel previously estimated.
- Growth forecasts were also revised higher. GDP is expected to expand by 2.0% this year from 1.7% previously. 2023’s forecast is now at 1.9% compared to 1.8% previously.
- The output gap is expected to turn positive in Q3 2022.
- The final vote was split 3-2, with two members voting for a 50bp rate hike.
- Investor appetite for risk globally is lower as financial conditions tighten.
Implications for SA markets
FRA: The SARB deliver a hawkish 25 bps rate hike, taking the Repo Rate to 4.25%. Three of the five members voted for a 25 bps hike, while the other two voted for a 50 bps rise in the repo rate. This shows that the SARB is committed to keeping inflation under control.
The SARB sees risks to the inflation outlook to the upside due to higher oil, power, and food prices as a result of the war between Russia and Ukraine. QPM interest rate forecasts were revised higher for 2022 and 2023. The upward revisions in the QPM resulted in some paying interest on the longer end of the FRA curve.
Our view is still that the credit cycle is weak and the growth outlook remains subdued, implying that inflation should remain relatively contained. Therefore, we expect three, potentially four more 25 bps hikes at the remaining meetings this year.
IRS: Post the SARB MPC rate decision, which was widely anticipated, swap rates have traded in a mixed fashion. Front-end rates have remained anchored, while a receiver bias is evident at the belly to long-end of the curve. The 2-year swap rate has remained unchanged, just north of 6.00%, while the 10-year has fallen by 8bps to trade marginally shy of 8.00 at the time of writing.
As a result, the 2v10 swap spread has narrowed as the curve bull flattens. Given the hawkish rhetoric from the Governor and the fact that it was a close call between a 25bps and 50bps rate hike, we could see the front-end remain supported. Growth risks, meanwhile, could keep rates lower at the long-end. We could therefore see the flattening bias persist in the near term.
Bonds: The hawkish hike underpins the notion that the broader flattening bias in the bond curve is expected to remain intact in the future. The topside revisions to inflation and interest rates will continue to buoy yields on the front-end of the curve, while looming growth concerns, notwithstanding the SARB’s comments about the output gap, will continue to weigh down yields further out on the curve.
Soaring international commodity prices also point to a sustained flattening in the curve with high commodity prices raising inflation risks (short term price pressures) while at the same time providing windfall tax revenue collections for the government (improved fiscal outlook).
ZAR: While a 25bp rate-hike was widely anticipated, the ZAR’s post-meeting reaction suggests the market did not expect two of the five MPC members to vote for a 50bp increase. The USD-ZAR nosedived more than 1% to a five-month low of R14.5700/$ before running into some support, with the ZAR bulls cheering the SARB’s hawkish forward guidance and rosier economic growth outlook.
Note that this move occurred despite broader USD strength on the day, reflecting just how resilient the ZAR has become to external headwinds recently. The hike and hawkish forward guidance increase the ZAR’s carry attractiveness profile, adding to its resilience which suggests that we could see further appreciation over the near term.
Bottom Line
The MPC voted 3-2 in favour of a 25bps rate hike at its March sitting, taking the repo rate to 4.25%, in line with economists’ and Bloomberg expectations. The split vote points to dissension amongst the policymakers, in what was by no means an easy decision as they seek to preserve price stability by countering the upward pressure of inflation and providing ongoing support to the economy.
The decision to hike would have been made easier by the Federal Reserve and other major central banks shifting their policy stances to even more hawkish amid the expected short term commodity shock.
Note that SARB has been prudent in its monetary policy, raising rates by a cumulative 75bps since the tightening cycle commenced in November 2021, demonstrating its commitment to restore medium-term inflation expectations.
Analysis
The SARB’s revised inflation forecasts were fairly hawkish due to higher energy and commodity prices from the effects of the war in Ukraine, heightening uncertainty in the future. Moreover, the expected Eskom tariff hike next month amongst other administered prices continue to present short-to-medium term risks. Specifically, the SARB anticipates inflation for the full-year 2022 to rise to 5.8% (vs 4.9% in January) and 4.6% in 2023 (vs 4.5%).
It is still premature to say the direct impact of the war on consumer prices in the upcoming months. The balance of these risks lies in Rand’s resilience to external shocks. We remain bullish on the Rand as it stands to benefit from the positive tailwind from the commodity boom. SA’s current account will thus remain in surplus for longer than previously anticipated, supporting the Rand.
The Bank, meanwhile, is more optimistic about SA’s economic growth as it gradually emerges from the pandemic. 2022’s growth forecast was revised slightly higher to 2.0% vs 1.7% at the January meeting, supported by a combination of factors, including a strong base from last year and higher commodity export prices. GDP growth is forecasted to be 1.9% in both 2023 and 2024. Even at these rates, growth remains well below its potential, and speaks to limited room to hike rates further if inflation pressures remain somewhat contained going forward.
With the higher growth and inflation forecasts, the SARB’s QPM model was adjusted to show a more aggressive rate hike path. The model now sees the Repo rate ending this year at 5.06%, suggesting three more rate hikes to come. The model then sees rates ending 2023 at just over 6%. This is overly hawkish in our view, with 2023 unlikely to see rates increase so significantly.
Going forward
While the current macroeconomic backdrop remains highly fluid, the decision to hike would go some way in promoting foreign inflows via a favourable interest rate differential and encourage investment and savings over consumption. Further interest rate hikes are still on the cards this year, which Governor Kganyago stated would remain data-dependent.
Based on yesterday’s decision, the likelihood of a steeper policy path ahead has increased.
From our standpoint, however, we view the more aggressive rate hike path as unwarranted due to the state of the underlying economy and the persistently weak credit cycle, which will help contain inflation going forward. Therefore, we are of the view that the market might be currently too aggressive in its pricing of rate hikes.