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Lower inflation signals possible rate cut

Johannesburg – The possibility of a rate cut before the year’s end has improved, given lower inflation as well as a narrower than expected current account deficit, say analysts.

According to Statistics South Africa (StatsSA), inflation eased to 6.3% for February, this was down from 6.6% reported in January.

READ: Consumer inflation eases to 6.3%

FNB economist Mamello Matikinca explained that although the South African Reserve Bank’s (SARB) outlook is more bearish, the possibility of an interest rate cut has not been ruled out.

Matikinca explained the persistent rand strength may contribute to a cut. However all eyes are on the Federal Reserve Bank’s (Fed) policy decisions. “We do not anticipate significant rand weakness, however, aggressive policy tightening in the US on the back of rising inflation remains a risk to the rand outlook,” she said.

Sanisha Packirisamy, economist at Momentum Investments said that lower food inflation would drive down headline and core inflation over the next 18 months.

Inflation expectations are for it to remain close to the upper band of the target for the five-year outlook.

She added however that a lower electricity tariff increase, will be reflected in July 2017 inflation and may provide further inflation relief.

The rand may strengthen on the back of higher commodity prices as well as global demand and interest rate tightening by the Fed.

READ: Bets are on first SA rate cut in more than four years

“However, political risks and lingering rating downgrade fears could spur some rand weakness into year end,” she said.

At the previous Monetary Policy Committee (MPC) meeting, the SARB warned that a volatile currency poses a threat to inflation.

Current account deficit impact on rand

The current account deficit narrowed to 1.7% in the fourth quarter of 2016, but over the medium term it is expected to average at 4%, said Packirisamy.

Among the contributing factors which led to the current account narrowing include higher commodity prices, improved terms of trade and increased dividend receipts. 

READ: SA current account deficit narrows to 1.7% of GDP

South Africa still remains reliant on net foreign portfolio flows to fund the current account deficit. “As such, SA will need to keep an attractive real interest rate profile, which limits the extent of the expected interest rate cutting cycle, which is likely to commence in late 2017,” she said. 

Of the current account deficit, Kevin Lings, chief economist at Stanlib said that domestic exports are expected to improve, despite the strength of the rand. The commodity price effect will drive this. Import demand is expected to remain stagnant given the “slump” in the domestic economy.

If the current account deficit improves over the next year, it will ease some of the pressure on the rand, he said.

“However domestic political risks intertwined with the on-going risk of a credit rating downgrade coupled with changes in global risk appetite are likely to keep the rand volatile in 2017.”

ALSO READ: Rand cheers narrow deficit, easing CPI

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