The split-decision of the Bank’s Monetary Policy Committee (MPC) to cut its repo rate by 25bps to 6.75% in July 2017 appeared to signal a shift in focus away from the risks posed by potential rand weakness to the recorded downside surprises in real GDP and inflation (and the subsequent downward revisions to GDP and inflation forecasts).
There are enough reasons to be wary about prospects for the rand. A combination of domestic economic policy uncertainty, the potential for further sovereign debt rating downgrades and a shift, although gradual, to less monetary accommodation amongst developed market (DM) economies, is not an ideal backdrop for the currency. But one cannot ignore the extent of downward revisions to inflation and growth forecasts by economists through this year. For example, at the conclusion of its May 2017 MPC meeting the Bank expected headline inflation to slow to 5.4% in the fourth quarter of 2017, although the MPC indicated at the time that the forecast did not adjust for the latest CPI print before that meeting. This forecast was revised lower to 4.7% at the July 2017 MPC meeting.
Meanwhile, in January 2017 the Bank expected real GDP to average 1.1% in 2017. At the conclusion of the July 2017 MPC meeting growth of just 0.5% was forecast for growth this year. The latest Stats SA GDP data release reflected a solid bounce in real economic activity in the second quarter of 2017 (2.5%), taking the country out of a brief and shallow recession. Even so, this improvement off a low base is probably not sustainable at this pace. For one thing, the manufacturing PMI business activity index collapsed to a level of 39.3 in July 2017, suggesting renewed weakness in manufacturing production. Accordingly, upward revisions to GDP growth forecasts, if any, following the second quarter print are likely to be modest and have limited impact on medium- to long-term inflation forecasts.
Together with the narrower current account deficit and modest private sector credit extension, especially to households, the downside surprises to growth and inflation complete a seemingly benign backdrop for monetary policy. It would, therefore, seem fair to expect another 25bps cut in the Bank’s repo rate at its September 2017 meeting. But the likely scale and timing of additional interest rate cuts, if any, is unclear – not least because of the deterioration in South Africa’s fiscal position in recent years.
Although fiscal policy does not appear to be a dominant consideration in MPC interest rate decisions at present, sound fiscal outcomes are essential to keep inflation expectations anchored. Further, the period of disinflation is expected to draw to a close during the first quarter of next year, when CPI is expected to bottom close to the mid-point of the Bank’s inflation target range. Thereafter, inflation is expected to increase through to year-end 2018 as the influences of currency stability, lower food price inflation and the low 2017 electricity price increase fade from the data.
On balance, considering the latent risks to the outlook, a shallow interest rate cutting cycle seems likely with at least one 25bps interest rate cut expected in September 2017. Will there be more? To answer I’ll quote from the Bank’s July 2017 MPC Statement: “In this highly uncertain environment, future policy decisions will be dependent on data outcomes and our assessment of the balance of risks.”