Repo rate unchanged after split vote

The repo rate will remain at its current level of 8.25% per year after three members of the South African Reserve Bank’s Monetary Policy Committee voted to keep rates on hold, while two members preferred an increase of 25 basis points.

South African Reserve Bank (Sarb) governor, Lesetja Kganyago, announced the decision of the Monetary Policy Committee (MPC) on Thursday afternoon. This decision was in line with the expectations of most economists, but there was some concern that the MPC would rather increase the repo rate after Wednesday’s announcement that the inflation rate increased by 0.1% in August.

Kganyago warned that the longer-term economic outlook is clouded by persistent risks to the inflation trajectory due to the negative effects of climate change and ongoing geopolitical tensions while financing conditions are expected to remain tight and growth modest in developing countries.

“While goods price inflation has eased in much of the world, core inflation remains elevated and oil prices increased significantly, keeping consumer price inflation from falling further. Globally, monetary policy is likely to remain focused on ensuring inflation continues to retreat. We expect markets in major financial centres to remain volatile.”

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Kganyago pointed out that despite considerable reprieve in the winter months, load shedding has increased and prices for commodity exports continue to weaken, while stronger El Niño conditions threaten the agricultural outlook in the near term, with global climate events present additional risks.

“Energy and logistical constraints remain binding on the growth outlook, limiting economic activity and increasing costs,” he says.

While households and firms show some resilience, Kganyago says economic growth has been volatile and highly sensitive to new shocks. “An improvement in logistics and a sustained reduction in load shedding, or greater energy supply from alternative sources, would significantly increase growth. At present, we assess the risks to the medium-term domestic growth outlook to be balanced.”

The current account deficit

Kganyago says South Africa’s external financing needs will increase as the current account deficit expands from a forecasted 2.0% of gross domestic product (GDP) this year from 1.9%, to 3.0% of GDP in 2024 and 3.4% of GDP in 2025.

“Sharply lower tax revenue, higher employee compensation and ongoing financing needs of state-owned enterprises are expected to keep the long-term cost of borrowing elevated. Despite the forecasted moderation of inflation, long-term bond yields currently trade around 12.6%.”

The rand depreciated by about 10% over the past year to date against the US dollar and shows high volatility in response to risk-on and risk-off episodes and the implied starting point for the rand forecast is R18.45 in the fourth quarter to the US dollar, compared to R18.13 at the time of the previous meeting.

The trajectory of South Africa’s headline inflation rate has been shaped primarily by fuel and food prices. Compared to the previous meeting, fuel price inflation is significantly higher at 0.4% in 2023, from -3.1%, rising to 5.8% in 2024. The Sarb’s food price inflation forecast for 2023 remains high and largely unchanged at 10.4% from 10.3%, while the forecast for 2024 also remains unchanged at 5.2%.

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Kganyago says better monthly outcomes led to a downward revision in the Sarb’s forecast for core inflation to 4.9% in 2023 (previously 5.2%) and 4.7% in 2024 (from 4.9%). “The core inflation forecast for 2025 remains at 4.5%. Services inflation in 2023 is expected to come in at 4.4% (down from 4.8%), primarily a result of lower public transport inflation outcomes.”

However, core goods inflation remains elevated and is revised slightly up for this year to 6.3% (from 6.2%). Growth in average salaries and unit labour costs is lower in 2023 and 2024, while salaries are expected to be slightly higher in 2025.

“With services inflation lower in the near term, headline inflation for 2023 is revised down to 5.9% (from 6.0%). The headline inflation forecast for 2024 increases slightly to 5.1%, before stabilising at 4.5% in 2025.”

Warning about risks for inflation increase

Kganyago warned that there are still risks that inflation can increase further, while headline inflation continues to moderate at a global level. However, food price inflation remains high, oil markets have tightened significantly and core inflation looks sticky.

“Despite recent easing in some food price components, domestic food price inflation was still elevated at 8% in August and the risk of drier weather conditions in coming months has increased. We expect food price inflation to moderate further in the near term, but with high risk that it picks up later in 2024.”

He also says in the absence of sustained increases in energy supply, electricity prices will continue to present clear inflation risks. “Load shedding and logistics constraints may also have broader effects on the cost of doing business and the cost of living. Given uncertain fuel and food price inflation, considerable risk still attaches to the forecast for average salaries.”

Sticky inflation implies that average interest rates in major economies will remain high and therefore, tighter global financial conditions are likely to persist, raising the risk profile of economies needing foreign capital, Kganyago says.

Higher inflation has generally resulted in elevated inflation expectations across businesses and households and Kganyago says while headline inflation returned to below the upper end of the inflation target range in June, the Sarb expects headline inflation to increase somewhat, before sustainably reverting to the mid-point of the target range in 2025.

MPC remains hawkish

The MPC remains hawkish and Kganyago says policy is restrictive at the current repo rate level, consistent with the inflation outlook and elevated inflation expectations. The MPC remains vigilant and stands ready to act should risks begin to materialise and decisions will continue to be data dependent and sensitive to the balance of risks to the outlook, he says.

“The MPC will seek to look through temporary price shocks and focus on potential second round effects and the risks of de-anchoring inflation expectations. Guiding inflation back towards the mid-point of the target band reduces the economic costs of high inflation and will achieve lower interest rates in the future.”

Kganyago says the MPC recommended additional means of lowering inflation within the reach of the public sector, including achieving a prudent public debt level, increasing the supply of energy, moderating administered price inflation and keeping real wage growth in line with productivity gains since early in 2020. “Such steps would strengthen monetary policy effectiveness and its transmission to the broader economy.”