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Hold your breath, consumers! A possible repo rate of 1% might be coming the back of even higher inflation.
Some economists expect a 75 basis points hike in the repo rate, along with inflation for June that will cross the 7% line, far above the effective inflation target of 4,5%.
Arthur Kamp, chief economist at Sanlam Investments, says the Monetary Policy Committee (MPC) of the South African Reserve Bank (Sarb) has plenty to think about this week before it decides on the repo rate, in a sea of uncertainty with growth forecasts revised lower.
“Following a bumper gross domestic product (GDP) in the first quarter of the year, the combination of the KwaZulu-Natal floods and loadshedding resulted in a material contraction in real GDP in the second quarter. At the same time, global recession worries surfaced, causing a murky outlook for commodity prices and domestic GDP growth heading into 2023.”
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The Bureau for Economic Research (BER) at the University of Stellenbosch, says although it is not its baseline, “we do not completely rule out the possibility that the Sarb could increase the repo rate by 100 basis points this week.”
The BER says the Sarb is widely expected to follow up the 50 basis points increase in May with a similar move, but there is an out-of-consensus view for an increase of 75 basis points this week due to:
In addition, the BER says after accelerating to a higher than expected 6.5% in May, the consensus is that the rate of increase for headline inflation will increase further to 7.3%, due to higher fuel, food and rental costs.
Kamp says the Sarb is unlikely to be deterred, not least because domestic inflation forecasts are being revised up.
“South Africa’s repo rate is still well below its neutral level and must be expected to continue increasing.”
He says there is little to be gained by second-guessing the size of this week’s likely Sarb interest rate hike and predicting the future in the current environment is hazardous.
“However, it seems reasonable to expect sustained further interest rate hikes heading into next year, probably to around 6 ½ % by the first half of next year when the outlook for inflation should be materially better.”
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One thing that can potentially change the expected path for the repo rate is the onset of a potential recession that is not driven by one-off impacts, which can reasonably be expected to reverse.
“However, recession is not the base case at present. In the interim, expect the Sarb to control what it can and stay the course.”
According to Kamp it is popular to view food and fuel price increases as one-off events that cannot be addressed by interest rate hikes.
“The problem is that second round inflation effects typically take hold if soft commodity prices remain elevated for an extended period.”
High fuel prices increase production costs and the shopping basket of poor South Africans is dominated by food and transport. Not surprisingly, wage demands are increasing amid rising inflation expectations, which should be reflected in upcoming inflation expectation surveys.
These are the channels through which food and fuel price increases feed through into core inflation.
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The BER also says the other important domestic event of the week, if it happens, will be a possible announcement by President Ramaphosa on urgent steps to resolve the country’s electricity crisis.
“In our view, the best outcome would be for the President to announce a range of steps to expedite the delivery of green energy projects that include shortening the environmental approval period and removing local procurement regulations for green energy projects.”
Kamp says the impact of electricity supply disruptions on real GDP is not easily estimated, but one mitigating factor is the decline in the energy intensity of production in South Africa since the 2000s.
“Nonetheless, mining production is still vulnerable. In the second quarter of 2015, during a period of similarly intense load-shedding, mining production decreased -4.3%. At the time real GDP contracted by a seasonally adjusted an annualised -3.3%. It would not be a surprise to see a similar contraction in GDP in the second quarter of this year.”
The BER says in addition the May activity data points to a bleak GDP outcome for the second quarter, with retail trade sales increasing by a much less than expected 0.1% in May, while manufacturing production declined by 2.3% in May.
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