Reserve Bank expected to leave repo rate unchanged on Thursday

Economists expect that the Reserve Bank will leave the repo rate unchanged at 8.25% although inflation for April dropped slightly by 0.1% to 5.2% from 5.3% in March. Although this decrease was welcome, it is unlikely to make a difference to the repo rate.

Tracey-Lee Solomon, economist at the Bureau for Economic Research (BER) at Stellenbosch University, does not believe that the downward surprise in inflation will sway the South African Reserve Bank (Sarb) to cut interest rates.

“This week’s global economic news was dominated by ‘central bank speak’. Fed governor Waller emphasised the need for several months of lower inflation data before considering easing monetary policy, citing little risk to the economy if rates remain restrictive for the next three to four years.”

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She says despite the hawkish tilt, recent comments and data suggests that rate cuts might still begin later this year, with markets anticipating two cuts starting in September. The next Fed meeting in June will provide more insights.

“The Sarb has emphasised upside risks to inflation and inflation expectations in recent meetings and a slightly softer touch on these issues could firm up expectations of a rate cut later this year. Indeed, while the US Fed has adopted a more hawkish stance, a lower oil price and stronger rand provide positive news for local inflation.”

Inflation decrease too slow for repo rate cut

Nicky Weimar, Johannes Khosa and Liandra da Silva, economists at the Nedbank Group Economic Unit, also expect the repo rate to remain the same. “We expect the Monetary Policy Committee (MPC) to leave the repo rate unchanged as inflation’s progress towards the Sarb’s 4.5% target remains slow.”

They believe inflation came out slightly better than expected in April and say the breakdown was also encouraging, while some upside risks to the inflation outlook also faded over the past month. “Although the stars are slowly aligning, the bar for a rate cut has not been cleared yet. Two months of inflation relief do not constitute a trend.”

The MPC would likely prefer more compelling evidence of consistent disinflation before shifting its stance, they say. “We still expect headline inflation’s descent to be frustratingly slow, stalling over the next two months before dipping below 5% in September and ending the year at 4.8%.”

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In addition, they point out, the risks to the inflation outlook are highly fluid in nature and consequently, they expect the Sarb to keep the repo rate at 8.25% at the next two meetings. “We expect conditions will gradually become more supportive of monetary policy easing over the next 4-5 months.”

They expect the first 25 basis points cut in September, followed by another of the same margin in November. “In our view, the SARB will likely wait for the elections to pass and for more evidence to emerge that inflation is trending towards 4.5% before easing monetary policy.

“The repo rate is forecast to end the year at 7.75%, taking the prime lending rate to 11.25%. Real interest rates will increase further, stabilising above 2% as inflation dips below 5% later this year and throughout next year.”

How is the rand doing?

Solomon says by Thursday’s close, the rand had depreciated against the dollar week-on-week after hitting its strongest level against the dollar since July last year earlier in the week. “The rand weakness was not just due to dollar strength as it also lost ground against the euro and the British pound.

She points out that the usually volatile rand has been relatively stable ahead of the upcoming national elections. South Africa has also been free from load shedding for over 50 days.

“In addition to higher non-oil commodity prices, this period of political calm, growing expectations of a market-friendly election outcome and a lack of electricity disruptions has helped the rand recover after being oversold earlier in the year.”

She says the future trajectory of the currency will largely depend on the continuation of these stable conditions.

Weimar, Khosa and Da Silva say oddly enough, the rand has enjoyed a relatively good spell of late. “It regained lost ground against most major currencies from around mid-April, strengthening further over May.

“On a trade-weighted basis, the rand appreciated by 6.2% since the end of February, taking its gains over the year to date to 4.2%. So far this year, the rand has been one of the better-performing emerging market currencies against the USD.”

They say the rand’s appreciation appears counterintuitive ahead of the highly uncertain outcome of the country’s general election on 29 May and last week’s signing of the controversial National Health Insurance (NHI) scheme into law.

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Investors less spooked by election

They also note that investors are less spooked by South Africa’s election. “They were encouraged by the latest polls, which showed fading support for the radical left Economic Freedom Fighters (EFF) and growing support for the ANC as the country enjoyed more than 50 consecutive days without rolling blackouts.”

In addition, the markets shrugged off the passing of the NHI bill, which could have severe implications for the country’s already compromised fiscal position and casts a long shadow over the future of the private healthcare system.

However, they expect the rand to come under renewed pressure over the next few months. “Investors’ nerves are bound to be tested around election time. The polls still point to the ruling ANC losing its outright majority for the first time since the dawn of democracy in 1994.

“If this happens, a coalition government will be on the cards, introducing a range of new uncertainties to an already murky policy landscape. In addition, SA still has a long road to travel towards fiscal sustainability, which depends on continued expenditure restraint. This task is difficult under a stable political setup and could prove even more challenging for a new and fragile coalition.”

Weimar, Khosa and Da Silva say the rand’s outlook beyond the election fog appears more promising. “Global risk sentiment should strengthen towards yearend as global disinflation gathers pace, the US and other major central banks start their rate-cutting cycles and the world economy gains mild upward traction. With the Rand undervalued, a revival in global risk appetites, a weaker US dollar and modestly firmer domestic growth prospects should provide grounds for a more sustained pullback.”