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THE quandary for the Reserve Bank remains unchanged, but the list of factors it is looking at and balancing out seems to get bigger, says Nomura emerging markets analyst Peter Attard Montalto.
The SARB MPC kept rates unchanged today at 5.00% as expected with a statement that was still broadly in the same “neutral” zone as before, though perhaps it shifted very slightly to the dovish end as one member thought about (though didn’t push the point) a cut.
We still think a cut this year is difficult without some pretty high hurdles being breached to “materially change the outlook” and so we still don’t pencil a cut in, even though we highlight September as a (non-baseline) possibility if it were to move.
The quandary for the SARB remains unchanged, but the list of factors it is looking at and balancing out seems to get bigger by the meeting. But those factors continue to net out.
Downside growth risks are increasing and indeed it revised lower its GDP growth forecasts to 2.4% for this year from 2.7% previously (we are still at 2.6%) and for next year down to 3.5% from 3.7% previously (we remain at 3.3%).
However, on inflation, while it has adjusted the forecast slightly to see only a temporary and much smaller breach of the target averaging 6.1% in Q3 and lower inflation averages at 5.2% for next year from 5.3% previously – the language on upside risks to inflation has intensified, and also there is the strong highlighting of the even more substantial risks to inflation if ZAR remains at current levels (which is our baseline on the currency, less in agreement on CPI follow through).
The lowering of both the inflation and growth forecasts however has clearly made an impression on one member, who pushed for a rate cut to be discussed, though as ever the MPC produced a unanimous decision in the end on its action to keep rates unchanged.
We don’t think too much should be read into this because we think that the Governor still holds sway over the MPC (unlike in Poland) and that the majority of MPC members remain of the view that the risk reward balance of moving rates at this juncture is far too skewed the wrong way and will still likely be in July and perhaps even September too depending on ZAR, global and domestic growth risks and labour issues. We therefore do not interpret this lone voice as a sign of a cuts discussion starting to build.
The MPC interestingly seems to see the further marked deterioration in the labour market situation, in the mining sector from downside growth risks (from sentiment and stoppages) and inflation risks (ie higher).
Its view here seems to have shifted vs recent weeks (that we highlighted in our Cape Town trip notes) in that before it was thinking that higher job cuts would offset higher wage increases – but the politicisation of job cuts and what has happened to Amplats has now meant that it sees higher wages, but not being offset fully by as many jobs cuts.
Hence it still uses the term wage-inflation spiral. We think the growth hurdles to a cut would be (unrealistically) significant if such a wage-inflation spiral was still likely (even if a tail risk as it still posits it now).
As expected it is highlighting the downside risks to growth from slowing credit growth and sees that as having been an important driver of consumption expansion until now. On external dynamics, it remains very bearish on the eurozone and other global factors, but on the US sees and acknowledges the recently stronger data, but then offsets that with concerns about fiscal drag from the fiscal cliff settlement.
The press conference also mentioned the ongoing work internally in the SARB of the risks to foreigner capital inflows reversing, though it admits some of these are sticky, and (in what seems a perfect example of their credibility) it talks about hedging risks of bond portfolios into ZAR weakness (when was the last time any other MPC mentioned that?), ratings downgrade risk from the labour situation and the concerns on the funding of the current account because of global liquidity bubble potential (their term).
This nexus of external (ultimately market) risks combined with its strong call to action by government and civil society to address low growth potential and competitiveness, FDI sentiment, electricity supply concerns and the downside risks to growth (which we think they are sceptical on the potential response by government).
Once again it resolutely makes the case that it is not its job to affect low growth caused by structural issues, and indeed impossible for it to do so with monetary policy, even if it wanted to. This grouping of risks, together with this last keenly nuanced political statement is why we think the hurdles to cuts remain high.
The MPC also addressed the market pricing of cuts (in response to a question we asked to the press conference online). “The market should not get ahead of itself” in pricing cuts was the answer, such a move would be “premature”. The Governor then went on to describe the balance of risks that meant that any firm expectations of a cut from here would be unwarranted.
This said, there was a surprising level of relaxation on ZAR, which we think shows that it can’t and won’t do anything about it directly (ie intervention), but also that it understands it naturally overshoots and indeed understands why because of the sapping of investor confidence due to domestic idiosyncrasies.
Additionally, as we have said in the past, we think the MPC is also “happy” (ie that is the right term) for a currency risk premia shock to occur to force the government to enact structural changes. The point shouldn’t be overlaboured however – it still gives the strong impression in the statement of the additional upside risks to ZAR if it should become stuck at current levels.
The end of the statement still suggests that a “material” change in the outlook is needed to alter rates (given the poorly skewed risk reward of making a shift in policy in our view).
It is clear therefore that the hurdles to a cut are very high and explains why we still don’t pencil a cut into our forecast, though we do still see a higher probability of a cut in September with the fall in inflation (ie a cut to keep real rates as negative as they are now).
The market likes to retort that there is bound to be a cut in July or September if ZAR is lower than currently, inflation is falling back on lower commodities, domestic growth is still weak and labour unrest stops.
Such logic is true and something we would agree with! The trouble is that this series of conditions only adds up to an unrealistic combination.
It shows the market does not understand the very structural and dangerous movements in the mining industry and labour market more generally that are set to deteriorate further from here in our view – leading at least to ZAR remaining at these levels, if not weakening further from here.
We think the only chance for a cut in September is if there is a slightly upside surprise to growth with inflation falling back strongly and ZAR clearly stabilised at weak rates due to ongoing labour market stress that hasn’t meaningfully deteriorated much further from where we are currently.
We think July is just too early with respect to the underlying wage round that is going on anyway. Additional external growth shocks would also likely be needed to shift the inflation/growth needle more decisively and tip this large list of risk factors for the SARB out of balance and into a cut.
Put simply – when and why would the skew in risk/reward for a cut for the MPC shift and are such expectations realistic? The answer to that questions leads us to keep our rates forecast unchanged.
*Peter Attard Montalto is a director and emerging markets economist at Nomura. Views expressed are his own.
The SARB MPC kept rates unchanged today at 5.00% as expected with a statement that was still broadly in the same “neutral” zone as before, though perhaps it shifted very slightly to the dovish end as one member thought about (though didn’t push the point) a cut.
We still think a cut this year is difficult without some pretty high hurdles being breached to “materially change the outlook” and so we still don’t pencil a cut in, even though we highlight September as a (non-baseline) possibility if it were to move.
The quandary for the SARB remains unchanged, but the list of factors it is looking at and balancing out seems to get bigger by the meeting. But those factors continue to net out.
Downside growth risks are increasing and indeed it revised lower its GDP growth forecasts to 2.4% for this year from 2.7% previously (we are still at 2.6%) and for next year down to 3.5% from 3.7% previously (we remain at 3.3%).
However, on inflation, while it has adjusted the forecast slightly to see only a temporary and much smaller breach of the target averaging 6.1% in Q3 and lower inflation averages at 5.2% for next year from 5.3% previously – the language on upside risks to inflation has intensified, and also there is the strong highlighting of the even more substantial risks to inflation if ZAR remains at current levels (which is our baseline on the currency, less in agreement on CPI follow through).
The lowering of both the inflation and growth forecasts however has clearly made an impression on one member, who pushed for a rate cut to be discussed, though as ever the MPC produced a unanimous decision in the end on its action to keep rates unchanged.
We don’t think too much should be read into this because we think that the Governor still holds sway over the MPC (unlike in Poland) and that the majority of MPC members remain of the view that the risk reward balance of moving rates at this juncture is far too skewed the wrong way and will still likely be in July and perhaps even September too depending on ZAR, global and domestic growth risks and labour issues. We therefore do not interpret this lone voice as a sign of a cuts discussion starting to build.
The MPC interestingly seems to see the further marked deterioration in the labour market situation, in the mining sector from downside growth risks (from sentiment and stoppages) and inflation risks (ie higher).
Its view here seems to have shifted vs recent weeks (that we highlighted in our Cape Town trip notes) in that before it was thinking that higher job cuts would offset higher wage increases – but the politicisation of job cuts and what has happened to Amplats has now meant that it sees higher wages, but not being offset fully by as many jobs cuts.
Hence it still uses the term wage-inflation spiral. We think the growth hurdles to a cut would be (unrealistically) significant if such a wage-inflation spiral was still likely (even if a tail risk as it still posits it now).
As expected it is highlighting the downside risks to growth from slowing credit growth and sees that as having been an important driver of consumption expansion until now. On external dynamics, it remains very bearish on the eurozone and other global factors, but on the US sees and acknowledges the recently stronger data, but then offsets that with concerns about fiscal drag from the fiscal cliff settlement.
The press conference also mentioned the ongoing work internally in the SARB of the risks to foreigner capital inflows reversing, though it admits some of these are sticky, and (in what seems a perfect example of their credibility) it talks about hedging risks of bond portfolios into ZAR weakness (when was the last time any other MPC mentioned that?), ratings downgrade risk from the labour situation and the concerns on the funding of the current account because of global liquidity bubble potential (their term).
This nexus of external (ultimately market) risks combined with its strong call to action by government and civil society to address low growth potential and competitiveness, FDI sentiment, electricity supply concerns and the downside risks to growth (which we think they are sceptical on the potential response by government).
Once again it resolutely makes the case that it is not its job to affect low growth caused by structural issues, and indeed impossible for it to do so with monetary policy, even if it wanted to. This grouping of risks, together with this last keenly nuanced political statement is why we think the hurdles to cuts remain high.
The MPC also addressed the market pricing of cuts (in response to a question we asked to the press conference online). “The market should not get ahead of itself” in pricing cuts was the answer, such a move would be “premature”. The Governor then went on to describe the balance of risks that meant that any firm expectations of a cut from here would be unwarranted.
This said, there was a surprising level of relaxation on ZAR, which we think shows that it can’t and won’t do anything about it directly (ie intervention), but also that it understands it naturally overshoots and indeed understands why because of the sapping of investor confidence due to domestic idiosyncrasies.
Additionally, as we have said in the past, we think the MPC is also “happy” (ie that is the right term) for a currency risk premia shock to occur to force the government to enact structural changes. The point shouldn’t be overlaboured however – it still gives the strong impression in the statement of the additional upside risks to ZAR if it should become stuck at current levels.
The end of the statement still suggests that a “material” change in the outlook is needed to alter rates (given the poorly skewed risk reward of making a shift in policy in our view).
It is clear therefore that the hurdles to a cut are very high and explains why we still don’t pencil a cut into our forecast, though we do still see a higher probability of a cut in September with the fall in inflation (ie a cut to keep real rates as negative as they are now).
The market likes to retort that there is bound to be a cut in July or September if ZAR is lower than currently, inflation is falling back on lower commodities, domestic growth is still weak and labour unrest stops.
Such logic is true and something we would agree with! The trouble is that this series of conditions only adds up to an unrealistic combination.
It shows the market does not understand the very structural and dangerous movements in the mining industry and labour market more generally that are set to deteriorate further from here in our view – leading at least to ZAR remaining at these levels, if not weakening further from here.
We think the only chance for a cut in September is if there is a slightly upside surprise to growth with inflation falling back strongly and ZAR clearly stabilised at weak rates due to ongoing labour market stress that hasn’t meaningfully deteriorated much further from where we are currently.
We think July is just too early with respect to the underlying wage round that is going on anyway. Additional external growth shocks would also likely be needed to shift the inflation/growth needle more decisively and tip this large list of risk factors for the SARB out of balance and into a cut.
Put simply – when and why would the skew in risk/reward for a cut for the MPC shift and are such expectations realistic? The answer to that questions leads us to keep our rates forecast unchanged.
*Peter Attard Montalto is a director and emerging markets economist at Nomura. Views expressed are his own.
