A Hard Choice for the SARB, but we Favour no Hike

South African currency

The South Africa Reserve Bank (SARB) could resume the short tightening cycle it started in 2014 when it meets on Thursday.  With markets split, we consider the internal and external factors arguing the case for a delay in raising rates.

The South Africa Reserve Bank (SARB) could resume the short tightening cycle it started in 2014 when it meets on Thursday, raising rates from the current 5.75% level. Markets are split, with 15 out of 26 economists surveyed by Bloomberg calling for a hike and the rest seeing no move. We are leaning towards delaying tightening a bit longer, but it will certainly be a close call.

There are plenty of internal and external factors arguing for a delay in hiking. On the external side, we don’t buy the idea that the SARB – or any other EM central bank, for that matter – needs to pre-empt a move by the Fed. Even if the Fed doesn’t move in September, as the majority believes it will, it is unlikely to make a big difference. The start of the Fed tightening cycle is well priced in and the rand has been in a pretty steady weakening trend since mid-2011 (see the weekly USD/ZAR chart below). Separately, the resolution of the Greek situation is a positive development for market stability, also helping to contain currency risk.

21-07-2015 11-02-41In addition, oil prices have moderated. The last monetary policy statement (21 May) noted several times how the recovery in oil prices has become an important source of upside inflation risk. However, oil prices have fallen around 16% since the last statement, taking back at least half of the increase MPC members were concerned about. Given the main driver attributed to the move – more supply from Iran following the agreement – it is unlikely that the bank will see the fall as transitory.

On the domestic side, the arguments against tightening are well understood: the lukewarm economy, energy production problems, high unemployment, and the negative growth impact of the labor disputes. Indeed, it is quite clear to us that price pressures are not coming from the demand side, which is the typical channel through which monetary policy is supposed to work.

We also recognize how the rise in inflation (and the upside risks ahead) underpinned the more hawkish stance by the SARB. For example, the most recent monetary policy statement noted that, “The deteriorating inflation outlook suggests that this unchanged stance cannot be maintained indefinitely.” It mentions the upside risks associated with higher electricity prices, the weaker rand, and wage disputes. Indeed, the latest BER survey showed a 0.2% increase in 2015 and 2016 inflation expectations, to 5.6% and 6.1%, respectively. This is in line with the central bank’s forecast of a temporary breach in the upper end of the 3-6% inflation target next year. The risks from higher wages are always heightened during South Africa’s “strike season” – the annual rite of strikes and stoppages as wage negotiations start. Wage negotiations are under way in the municipal sector following the expiry of a three-year agreement. The major unions have so far rejected the company offers that would raise wages by as much as 13%. With gold prices plunging still, we do not think the gold companies can offer too much more in the way of wage concessions.

It’s a close call but, on balance, we think that the optimal move for the bank right now is to keep up the hawkish stance but refrain from acting. The bank has enough credibility; nobody doubts it will act if necessary. But there are enough domestic and external developments to justify a more patient approach. For this reason, we doubt there will be anything more than a temporary move lower in the rand should the bank decide to stay on hold. The impact may be more important in the fixed income markets, however, with the curve bull steepening.