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A more hawkish and cautious response to local interest rates is warranted, argues BNP Paribas' Jeffrey Schultz.
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The first South African Reserve Bank monetary policy committee of 2023 takes place next week, culminating in a policy-rate decision, statement and press conference on Thursday 26 January.
We maintain our call for a 50 basis points (bps) rate hike to 7.50%.
Global financial markets have begun the year on the front foot, buoyed by disinflation taking hold, better growth and activity outcomes and a (growing) expectation that major central banks will be able to take their foot off the hiking pedal soon.
South Africa’s local rates market has largely mirrored these trends, with forward rate agreements now pricing in a much more muted 25bps hike from the SARB next Thursday.
While we have sympathy for the "don’t fight the Fed" view alongside this week’s downside core CPI surprise (4.9% y/y from 5.0%) warranting a larger downshift, we still see a number of idiosyncrasies facing South Africa’s own inflation and policy backdrop that could warrant a more hawkish and cautious response from a (slim) majority of the five-person monetary policy committee (MPC) next week.
We frame five arguments for a 50bps hike on 26 January.
What is driving disinflation matters
Most of the non-core disinflation South Africa is likely to observe over first half of 2023 will be concentrated in fuel, we believe. Although manufactured food prices have begun to come off, agriculture product prices are still rising rapidly and are likely to be made worse by electricity supply disruptions, forcing more generator (diesel) usage for the energy intensive agriculture industry (and industry at large).
Eskom has indicated it will have to curtail its diesel-heavy open cycle gas turbine (OCGT) usage as it looks to bring down rampant costs (OCGT usage spiked 114% in December and was up 42% in April through December 2022), but this will come at the expense of higher diesel costs for the private sector as severe load shedding looks set to persist, we warn.
December’s CPI report showed that most of the moderation in core prices was driven by rentals, with three-month seasonally adjusted and annualised momentum in core prices holding firm at 5.5% thanks to sticky core goods prices.
Core inflation is still rising
Despite two consecutive months of downside core CPI surprises, we still expect this to only peak closer to 5.5% around the middle of 2023, due to elevated input/intermediate costs (described above).
The energy regulator’s decision to award Eskom an 18.65% tariff hike this year (adding up to 0.2pp to SARB’s 2023/24 CPI estimates, we think) will also add to second round effects into core CPI down the line. This should see stronger upward revisions to the SARB’s administered price assumptions it factors into its quarterly projection model (QPM) – the SARB had pencilled in an average electricity tariff of 9.0% for 2023.
Inflation expectations continue to rise, will likely remain sticky
This is evidenced by the Bureau for Economic Research fourth quarter 2022 inflation expectations report published earlier this week, which showed a 0.3pp rise to 5.6% for 2-year expectations (the SARB’s preferred tenure of measure).
Though one can argue that this is backward-looking (and perhaps expectations in the first quarter will decline again just on the fuel price declines in January), the SARB is unlikely to be comfortable that two-year expectations have now moved more than 1pp above its preferred 4.5% midpoint.
More generally, we are skeptical that expectations will come down quickly in light of the administered price challenges (the fourth-quarter expectations survey was conducted before the electricity tariff decision) mentioned above, the lagged impact of multi-year wage settlements closer to 6.0% per annum, and services prices continuing to rise.
The rand remains vulnerable on a weaker fundamental story
The US dollar has begun to weaken earlier than we expected in 2023, helped by a market expectation that the Fed funds rate is nearing its peak (premature, we think), and perhaps that the European Central Bank will have to play ‘catch-up’ as growth and activity in the region look to be faring better than originally feared. However, the domestic fundamental story for the rand is one of vulnerability, we think. In particular, we think a combination of lower carry, larger current-account deficit, lingering political uncertainty and what we believe are underappreciated local growth problems are likely to weigh on the currency over the coming months.
As a result, we think that the SARB will be hesitant to significantly strengthen its previous dollar-rand starting point of 17.76 in its quarterly projection model.
Neither do we see meaningful appreciation for the rand in real-effective exchange rate terms in this environment.
Testing the political commitment to SARB independence
While this might not necessarily swing the quantum of hike next week, the SARB is likely to comment on the recent policy proposal from the ANC to expand the SARB’s constitutional mandate to explicitly include job creation. While this debate arises every five years or so and is therefore not a new theme, we see an emboldened push within the ruling party to bring it back onto the policy agenda when the ANC releases its policy resolutions, which could be any week now.
At the same time, politicians and policymakers have made it clear that SARB independence will be kept sacrosanct. In that respect, a bolder 50bps hike from the SARB next week would explicitly test this narrative at a time in which the economy is reeling from debilitating electricity supply cuts. We think the SARB will want to show its resolve to stick to its functional inflation targeting mandate as a means of safeguarding its current constitutional mandate of "protecting the value of the currency in the interest of balanced and sustainable economic growth, without fear, favour or prejudice".
Another divided decision?
We acknowledge the uncertainty around the above views; some SARB members might wish to take a more cautious approach given recent core CPI trends and expectations of a larger US Fed downshift to 25bps next month, and to allow for some more evidence of monetary transmission to present itself given the 350bps of tightening the SARB has already delivered this cycle.
This underpins our belief that the committee could well be heavily divided on the size of next week’s hike, and would not be surprised to see a 3:2 split in favour of 50bps.
Ultimately our expectation for a 50bps hike next week, followed by a final 25bps hike in March, is premised on our view that the SARB will struggle to bring inflation and inflation expectations back towards its 4.5% midpoint target in our forecast horizon (end-2024).
Jeffrey Schultz is the chief economist for the Middle East and Africa at BNP Paribas. News24 encourages freedom of speech and the expression of diverse views. The views of columnists published on News24 are therefore their own and do not necessarily represent the views of News24.
