Interest rates - where to from here?

Cape Town - SA’s monetary policy stance remains accommodative, the Monetary Policy Committee (MPC) of the SA Reserve Bank (Sarb) indicated at its latest rates announcement on Tuesday, according to Sanisha Packirisamy, economist MMI Investments and Savings.

A marginally weaker outlook on domestic growth, constrained by subdued business and consumer confidence and elevated global uncertainty, together with marginal upside risks to the Sarb’s upwardly-revised inflation forecasts left the committee members in agreement on keeping the repo rate unchanged at 7%.

"Real interest rates in SA appear to be less attractive than those in other key emerging markets, while our current account deficit remains uncomfortably wide. As such, any wobble in global risk sentiment could put the domestic currency at risk," explained Packirisamy.

"In our view, the sustainability of recent rand strength remains the key source of upside risk to our inflation profile. However, if inflation continues to moderate in line with our expectations from around 5.5% this year to below 5.0% in 2017, this trajectory should create some leeway for the Sarb to consider cutting interest rates in the latter half of 2017."

According to Packirisamy, there are risks to this view. Interest rates could rise more aggressively than expected in the US, international oil prices could tick significantly higher and/or negative global trade policies could gain traction.

"Under this scenario, emerging market currencies (including the rand) could weaken thereby lowering the prospect of interest rate cuts domestically, particularly if the sell-off in the local unit is sustained and manifests in the form of higher inflation expectations," she said.

Unlikely cuts

According to David Crosoer, executive of research and investments at PPS Investments, it looks unlikely that Sarb will cut interest rates anytime soon.

"Despite a stronger-than-expected rand, the Sarb now sees a worse-than-expected inflation outlook in 2017, while it has also trimmed its economic growth assumption for 2017 to 1.1%. While the Sarb has now left the repo rate unchanged at 7% over the past 10 months, the market possibly got ahead of itself in arguing that the interest rate cycle has already peaked, given inflation remains stubbornly high," said Crosoer.

"The economic environment remains highly uncertain, and as such, we encourage investors to remain diversified and not over exposed to any particular outcome materialising."

Hawkish stance

Tumisho Grater, economic strategist at Novare, said the Sarb’s hawkish stance has been driven by the ever-present risks on the horizon that have created a substantial amount of uncertainty.

"Inflation expectations, the global economic and political landscape along with expectations of a tighter stance of monetary policy by the US Fed are some factors the Sarb is watching closely in order to protect the value of the rand in one’s pocket," he said.
 
"Although the rand has displayed a degree of resilience since the previous MPC meeting (and the pass-through to inflation has been relatively muted) the local unit remains vulnerable to both domestic and external shocks. The Sarb is projecting a gradual pace of tightening with the rand vulnerable to any upside surprises in this respect."

Uncertainty of scale

Arthur Kamp, investment economist at Sanlam Investments, said Sarb’s statement relating to the rates decision reflects on the uncertainty of the scale of possible economic policy changes in the US under a Trump administration and their potential impact on emerging markets.

"There is a real risk that the US Federal Reserve could be more aggressive than we would like in hiking its policy rate. If so, this risks currency depreciation and possible upward pressure on interest rates for emerging market countries like SA, which are running macroeconomic imbalances and rely on foreign capital inflows to supplement domestic savings," said Kamp.   

"But, most importantly, the Reserve Bank’s inflation forecast deteriorated and the Bank now expects the annual advance in headline consumer price inflation to return to below the 6% upper limit of the Bank’s inflation target range by the final quarter of 2017 only, while inflation is expected to average 6.2% in 2017, significantly higher than the Bank’s previous average forecast of 5.8%."