The backdrop to South Africa’s monetary policy committee’s (MPC) meeting this week seems all too familiar.
One protracted strike has ended, but another larger one has started. The bleak growth outlook appears only to be weaker, and Moody’s, the rating agency, has issued a grim warning about the impact of industrial unrest and the potential risks to the country’s credit rating.
Yet for the first time in a while there does not appear to be a clear consensus on whether the MPC will keep rates on hold or raise them.
“Yes, for the first time in a long time there is divergence in expectations around the rates decision. I expect the SARB (the central bank) to raise rates by 50bps mainly on rising inflationary pressures emanating from the weak exchange rate,” says Thabi Leoka, economist at Renaissance Capital. “The balance of probabilities tilt more towards a hike.”
Annabel Bishop, economist at Investec, leans the other way. She said in a note:
“The fragility of the SA economy indicates that no interest rate hike is currently needed, with demand-led price pressures subdued and inflation expectations anchored since the last MPC meeting – we expect interest rates will be left unchanged at the July MPC meeting. Monthly economic data readings for Q2.14 to date show further contraction on a three month rolling average basis (seasonally adjusted and annualised to replicate the calculation method for GDP).”
The differing opinions highlight the “policy dilemma” that Gill Marcus, the central bank governor, has been citing throughout this year - the balancing act the MPC is burdened with as it juggles the country’s tepid growth alongside rising inflation.
Inflation targeting – keeping inflation in band of between 3 per cent and 6 per cent – is MPC’s main focus – a point it reinforced when it surprisingly raised the repurchase rate by 50 basis points to 5.5 per cent in January. Rates are still at 30-year lows and Marcus has repeatedly said the bank is a “rising interest rate cycle.”
Consumer Price Index (CPI) inflation, driven in part by the weak and volatile rand, ticked up from 6.1 per cent in April to 6.6 per cent in May.
So it is completely rational to assume that a rate rise is in order.
But then again, the growth outlook has gone from bad to worse. An unprecedented five-month strike that crippled the operations world’s three top platinum producers – Anglo American Platinum, Impala and Lonmin – finally ended in late June.
But only after it had pushed the economy into a 0.6 per cent contraction in the first quarter and cost the companies more than $2bn in lost revenue. And just as some 70,000 striking miners were returning to work, 220,000 metalworkers and engineers downed tools in their own wage dispute.
Now in its third week, the strike – called by South Africa’s largest union, Numsa –is wide reaching and has caused auto manufacturers, including Ford, BMW, General Motors and Toyota, to suspend or reduce production. This is in a sector that is a crucial component of manufacturing and the country’s exports as the nation’s grapples with a stubbornly wide current account deficit.
Obviously the duration of the strike will determine just how damaging it is. But economists are already forecasting growth for the year of below 2 per cent – following on from anaemic growth of 1.9 per cent last year.
Still, Leoka says local real interest rates remain low versus other emerging markets, making the rand vulnerable, while a rise in interest rates could strengthen the currency and dampen inflationary pressures. She adds that substantial wage increases being demanded by unions could also add to inflationary pressures, while noting that public sector salary negotiations are due later this year.
“We are still in a stagflation bind, but the primary mandate of the SARB is price stability,” Leoka says.
Others share similar views.
Peter Attard Montalto at Nomura said he is also a expecting a 50 basis point hike “with a still strongly hawkish statement but a split decision.”
“We see a very reluctant MPC having to hike within an extremely difficult growth/inflation mix. However, we suspect at least two of the seven MPC members would not back a hike at this stage given the weakness of growth and given the lack of FX pass-through rate normalisation so far with such low growth. Broadly, however, we see the median of the MPC as influenced by the argument of the hawks on the committee about the risks of not hiking, the fear of inflation and the (limited) front-running argument – ie, better to hike now and less overall than to risk having to hike more.
“Overall, then, we see a rough split of probabilities of 50 per cent likelihood of a 50bp hike, 20 per cent likelihood of a 25bp hike and 30 per cent likelihood of rates unchanged. This compares with market expectations of around 28bp (vs our blended probability of 30bp).”
Bishop at Investec, however, believes the data argues against a rise this month, and instead sees a 25bp increase in November.
“What is clear is that July is not an opportune time to raise interest rates in SA, even a 25bp hike is likely to see significant rand depreciation as foreigners see worsening prospects for growth as a result, and so likely sell some of their holdings of SA equities,” she says.
Of course the view that really matters is that of the MPC. All will be revealed on Thursday afternoon.
One can only imagine that given the complexities of the “policy dilemma” there will be robust debate MPC’s members over the next 24 hours, no doubt accompanied by much head scratching.
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