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Cape Town - The SA Reserve Bank (Sarb) remains entangled in a very different policy dilemma of stagflation, Futuregrowth Asset Management said in its monthly review for March.
"Inflation at both producer (8.1%) and consumer (7.0%) levels have surprised many with the speed of acceleration, while economic growth remains anaemic. In addition, the particularly precarious balance of payment position - both in absolute and relative terms - necessitates a higher real repo rate," according to the review.
In Futuregrowth's view, to the Sarb’s credit, it continued to focus on its mandate of maintaining price stability and for that reason raised the repo rate by another 75 basis points (bps) over the past quarter. As result, the repo rate has now increased by 2% from the cycle low.
Locally, the combination of sustained and broad-based rand weakness and fast rising food prices have pushed Futuregrowth's 2016 and 2017 annual average inflation forecasts to 6.6% and 5.8% respectively.
"We shall be keeping one eye on the core measure of inflation for a more reliable indication of underlying inflationary pressure, which is still below 6%, but rising," according to the review.
"Evidence of rand weakness pass through is starting to show, but is not particularly broad based yet. The risk remains that this will eventually follow."
Futuregrowth noted with what it called "a fair degree of concern" that SA is still saddled with a relatively weak external trade position, which in turn will remain a drag on the rand.
"It remains a significant challenge to fund the shortfall considering the global backdrop and the relative unattractiveness of SA as a longer-term investment destination," said Futuregrowth.
"Similarly, it leaves the Sarb with less room to manoeuvre since a deficit of this magnitude implies a higher real repo rate."
Futuregrowth feels comfortable with what it calls the prospects of a very gradual Sarb MPC tightening process, especially considering that the repo rate has already been increased by a cumulative 2% in the current cycle.
"A cautious approach is supported by the weak economic growth backdrop, low levels of credit extension growth and limited evidence of demand-led inflation. Unfortunately, the monetary authorities cannot ignore rising cost pressures, especially those originating from food prices, energy prices and persistent currency weakness," it pointed out.
"Moreover, monetary policy, even if credible, cannot be considered in isolation. It goes hand in hand with fiscal prudence and a more balanced external account. Considering the size of the balance of payments deficit, the real repo rate remains too low."
As a result, Futuregrowth said it will approach the SA market with caution and retain its holding of low duration inflation-linked bonds. In its view, Sarb will need to raise the repo rate again, a move already anticipated by both the money and bond markets.
"At face value, this backdrop favours an overweight position in cash, underweight position in nominal bonds and the further accumulation of inflation-linked bonds. However, in acknowledgement of the fact that markets move fast in pricing risk, we would retain a small overweight exposure to long-dated nominal bonds," states the review.
