All eyes on repo rate after surprising inflation decrease

As the country records a decrease in inflation, the Monetary Policy Committee (MPC) of the SA Reserve Bank (Sarb) will sit on Thursday to decide on interest rates. Will it affect their decision? Can we now hope for no change?

The South African Reserve Bank (Sarb) has a constitutional mandate to protect the value of the rand by keeping inflation low and steady and uses interest rate to influence the level of inflation.

Inflation decreased by almost one percentage point in June to 5.4% from 6.3% in May. It is at its lowest level since October 2021, and below the upper limit of the South African Reserve Bank’s monetary policy target range of between 3 and 6%.

So what do the experts predict from tomorrow’s MPC meeting?

ALSO READ: Inflation decreases by almost one percentage point in June

Sanlam says no change

Arthur Kamp, chief economist at Sanlam Investments, believes the MPC will leave the repo rate unchanged now inflation is slowing down.

“Admittedly, increasing inflation expectations will likely still concern the MPC members. The Bank has previously noted that recent sharp currency depreciation could lead to wage–price spirals.”

He said “first-round” import price increases, such as petrol, could prompt workers to demand higher wages leading in turn to higher price increases. Along with increased production costs, this could lead to damaging wage-price spirals if left unchecked.

He thinks the MPC will take note of the further increase in inflation expectations reported in the Bureau for Economic Research’s (BER) Survey of Inflation Expectations for the second quarter of 2023.

Specifically, inflation expectations of trade unions remain elevated at 6.6% for 2023 and 6.2% for 2024, while households also have high inflation expectations at 8.1% for the year ahead. So there is limited signs of a damaging wage-price spiral developing.

“Against this backdrop, the recent relative stability of the rand exchange rate is a favourable development. When the Sarb increased its repo rate by 50 basis points to 8.25% at its last meeting in May, it left the door open for additional interest rate hikes, signaling inflation risk is skewed to the upside.”

Kamp said the question is whether the adjustment is enough.

It is difficult to assess, since monetary policy works with a lag, but the inflation rate for June confirms that disinflation is under way.

“Inflation is now significantly down from the peak of 7.8% reached in July last year. Historically, under inflation targeting, the interest rate hiking cycle has peaked once inflation has peaked. Considering this and given little, if any expected real GDP growth in 2023, while real credit extension is palpably weak, there is a strong argument to pause at this MPC meeting.”

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Oxford Economics Africa says it will be a tight call

Jee-A van der Linde, senior economist at economic research group Oxford Economics Africa, said the June inflation rate is the third consecutive favourable inflation outcome, and means that South Africa’s headline inflation rate is back in target range.

“The impact of tighter monetary policy is beginning to show and with previous rate increases yet to fully filter through to the real economy, another rate increase by the Sarb will most certainly make it unpopular among struggling consumers.”

However, South Africa’s average inflation expectations for 2023 increased to 6.5% and for 2024 to 5.9%, after the most recent quarterly survey.

“The Sarb has consistently said it is determined to re-anchor inflation expectations around the midpoint of the inflation target band (4.5%). Favourable base effects will fade over the coming months, which should see inflation flatten out and become sticky at levels too high for the Sarb’s liking.”

At the previous policy meeting in May, the Sarb said monetary policy has only now become restrictive and, given weak domestic demand, further tightening might prove too restrictive.

“The moderation in both core and headline inflation has reduced our subjective odds of an additional rate hike in July and sets the scene for the Sarb to make a tight call tomorrow,” Van der Linde said.

ALSO READ: Inflation expectations before next repo rate meeting

Nedbank Group Economic Unit says case for no further hikes

The Nedbank Group Economic Unit said Wednesday’s inflation outcomes are encouraging and it expects inflation to remain below 6% for the rest of the year, ending the year at around 5% with the downward trend mainly come from fuel and food prices.

“The weaker global economy will contain the price of Brent crude oil, which will translate into lower fuel prices. Food prices are also expected to continue to fall off a higher base as the lagged effect of the drop in global prices continues to filter through the economy.”

The unit said there are upside risks attached to food inflation, coming from higher domestic production costs that include the cost of sourcing electricity from diesel generators due to persistent load-shedding and a vulnerable rand.

“The El Niño weather pattern, associated with drier weather conditions, is predicted to occur this year and introduces another uncertainty for food security. However, weaker domestic demand will increasingly erode companies’ pricing power, containing the rate at which firms can pass cost increases onto consumers without reducing sales significantly. This will contain the rise in core inflation.”

Before the release of today’s inflation rate, the unit expected one last 25 basis points rate hike.

“Given the uncertainties surrounding load shedding and the rand, we feel the Monetary Policy Committee (MPC) will remain cautious.

“However, today’s numbers strengthen the case for no further hikes. The better-than-expected outcome comes on top of the rand’s pullback to below R18 to the US dollar, a faster deceleration in US inflation and more evidence of slowing global and domestic demand.”

It said tomorrow’s rate decision will still be a close call, but inflation’s return to the target range increases the chance the MPC will leave interest rates unchanged, which could be the peak in the rate cycle.