The Monetary Policy Committee of the SA Reserve Bank (Sarb) is likely to keep interest rates unchanged at its meeting on Thursday, according to international market research company Citi Velocity.
“Our baseline forecast is that the repo rate will remain unchanged at 6%. That said, it is another close call,” the company said in an overview.
The Sarb will only hike if it’s inflation profile results in a two-quarter breach (extended) and we see this unlikely, Citi Velocity said.
“The quarters surrounding the Sarb’s Q4 of 2016 breach of 6.2% are very close to the target ceiling and, therefore, it wouldn’t take much to push the Sarb’s inflation forecast to a two-quarter extended or prolonged breach.”
Going by the Sarb’s track record for this hiking cycle so far, it is a two-quarter or longer breach that is deemed as intolerable and requires further tightening, Citi explained.
It pointed out that the sharp move in the dollar/rand spot since the US non-farm payroll data surprised to the upside, has almost fully convinced the markets – with a 70% probability – that the US Federal Reserve will hike in December. This explains why some experts are pricing in a 60% chance of a 25 basis point rate hike by the MPC this week.
Citi cautioned, however, that the MPC has often stated that even if the Fed did hike, it wouldn’t necessarily have to move in step with it. On top of that, Citi pointed out that the MPC does not directly intervene in the currency, so the foreign exchange would need to result in an extended inflation breach of the 6% target ceiling.
“The dollar/rand has actually depreciated less between the September MPC and November MPC meetings (3.1%) than between the July MPC and September MPC meetings (11%), when the Sarb kept rates unchanged,” said Citi.
“Foreign exchange volatility is also important, because it is often believed that corporates are unable to manage sharp moves in the currency as well and hence are more likely to pass it through to consumer prices.”
Citi views the Sarb as an inflation-targeting central bank and, therefore, says what matters to the central bank is what it expects for the rand and – most critically – how this passes through to consumer inflation.
“This is where the greatest risk lies to our unchanged stance for this week’s MPC meeting. There is a reasonable probability that the Sarb weakens its foreign exchange outlook, and if so, more upward price momentum would arise in its first half of 2016 forecasts where the third quarter currently averages 6% and the fourth quarter of 2016 averages 6.2%.
“Though the Sarb will base its MPC decision on its own calculations, we believe that pass through in general – FX and other cost push pressures – has reduced this year. Downside surprises in gross domestic product (GDP) forecasts so far this year and consistent downgrades to the GDP outlook match the fact that the consensus has mostly overestimated inflation,” Citi explained.
Since the September MPC meeting, the oil price has fallen a further 7.5%, but Citi thinks the Sarb may attach a higher risk to food inflation due to the severe drought as well as import requirements for wheat and maize.
“Following 15 years of inflation targeting, the Sarb has built up a lot of credibility, particularly relative to its emerging market peers. This, alongside an inflation trajectory that drifts toward the top end of the 3% to 6% target range in 2016, are the reasons why, in our view, the MPC’s rhetoric will remain hawkish this week,” Citi said.
“However, in the interest of GDP, there is no obvious reason to hike right now.”
Carin Smith, Fin24
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