Why the Reserve Bank didn’t cut rates
Concerns about the risks building against the rand dominate the MPC. But a split between hawks and doves on the committee makes the outlook on rates uncertain
The big question after the Reserve Bank’s failure to cut rates last week is whether it is going to make any further rate cuts this year. There is even the possibility that the Bank’s next move could be a rate hike.
The voting pattern at last week’s monetary policy committee (MPC) meeting reveals that it is split between four hawks and three doves, suggesting that the next few meetings are going to be a very close call.
Though the Bank’s inflation and growth forecasts have barely changed since the last MPC meeting in July, the MPC feels that the balance of risks to inflation have increased to the upside.
The MPC statement identifies several worrying risks to the inflation outlook, but only two positive factors that could result in a better inflation profile: the prospect that domestic economic growth and food price inflation could turn out lower than expected.
As ever, the rand remains its key concern. This is because a sustained weakening of the exchange rate could lead to higher inflation.
The MPC’S fear is that should inflation and/or growth move higher than expected in Europe and the US, it could speed up global monetary tightening, which could negatively affect capital flows into SA, hurting the rand.
The rand could also be hit if SA were to suffer any further ratings downgrades, something that remains a risk given SA’S “increased fiscal challenges and political uncertainty”, the MPC noted.
The MPC also emphasised that certain event risks are more imminent, presumably referring to the ANC’S December elective conference, the October medium-term budget and the November credit-ratings reviews.
“The rand remains sensitive to political developments, weak economic growth prospects and the risk of further sovereign ratings downgrades,” the MPC said.
Moody’s and S&P Global Ratings both have SA’S local-currency rating pegged on the cusp of junk with a negative outlook. There is a risk that they could junk the rating after the medium-term budget in October if SA’S fiscal consolidation plan is derailed.
If they do so, the country will be ejected from the World Government Bond Index, which would force several large investment funds to divest of their SA holdings, causing a capital outflow of up to R150bn, by some estimates.
The rand could be in for a bumpy ride over the next few months given not only these domestic hurdles but also the huge risks associated with the December meetings of the US Federal Reserve and the European Central Bank.
This backdrop could make it more challenging for the Bank to ease rates at the November meeting. There may be even fewer MPC members voting for a cut than at last week’s meeting.
A further upside risk relates to the possibility that Eskom could be awarded a larger electricity tariff increase in July next year than the 8% the Bank has assumed. Eskom is asking for a 20% increase.
“The bulk of the statement was quite solidly neutral, but flecked with little pieces of hawkishness,” says Nomura economist Peter Attard Montalto. He thinks the 25 basis point (bps) June rate cut, which took the repo rate to 6.75%, may be the only one SA is going to enjoy this year and that the Bank made the right decision in not cutting again last week.
The problem in forecasting the rate outlook, he says, is that the MPC is split between a group of doves, who are happy to discount some of the potential risk to the rand and a group of hawks, whose “fear” around inflation risk prevents them from cutting rates.
Stanlib chief economist Kevin Lings puts it well: “Ultimately, the Bank has to balance the current lower growth/lower inflation data against the risks associated with SA’S increased vulnerability to changes in foreign capital flows. The next few interest rate decisions by the MPC are not going to be easy and the rate outcome will probably remain a close call.”
Those who expect the Bank to cut rates again are typically optimistic about inflation and bearish on growth.
Capital Economics’ John Ashbourne says: “Given the recent slowing of inflation, the weak state of SA’S economy and the divided nature of the MPC, we expect that today’s decision represents only a brief pause in the country’s loosening cycle.”
He believes that by the time of the November meeting, inflation will have eased further and economic growth will also probably be weaker.
As such he expects another 25 bps cut at the November meeting.
But Attard Montalto fears that concerns around SA’S fiscal situation, credit ratings prospects and domestic politics could come to dominate the MPC’S thinking.
In fact, he warns that SA could experience hikes of 50 bps or more if these risks materialise and cause disorderly outflows from SA’S capital markets. Conversely,
50 bps of possible rate cuts could occur if SA achieves a ratings reprieve and political events deliver a benign outcome over the turn of the year.
In short, the situation is wide open and impossible to call. The MPC is going to have to tread carefully from meeting to meeting. It is likely to err on the side of caution and keep emphasising that it is not in a cutting cycle and that its decisions remain data dependent.
TIME TO PAUSE