Amid the Brexit gloom, a rates silver lining for SA

GLOBAL inflation remains muted, particularly in advanced economies. In fact, the Japanese and the eurozone economies are suffering from deflation.

In the US and the UK, headline inflation is also well below the targeted levels, although some acceleration is expected next year.

Global economic growth is pedestrian, stuck at a belowpotential rate of around 2.5% for the past five years. The weakest link among advanced economies is Japan, which grew by less than 1% last year and is expected to do so again this year.

The US economy, which posted relatively solid growth in 2014 and 2015, decelerated noticeably over the past three quarters.

Europe was expected to be a bright spot, delivering gradual but consistent recovery due to easy funding conditions brought about by the European Central Bank’s substantial dose of stimulus. However, Brexit has impaired the outlook for the UK and European economies and increased downside risks to global growth. As a result, expectations of further monetary easing by the major central banks are rising.

The Bank of England is expected to cut rates by 50 basis points to 0% by the end of this year. The Bank of Japan is expected to cut rates deeper into negative territory, the ECB is expected to at least extend the duration of its quantitative easing programme and the US Fed is expected to postpone rate hikes to early next year.

The rising expectation of further monetary policy easing within advanced economies is reflected in the post-Brexit slide in global bond yields. The French and UK 10-year bond yields are significantly lower than their late-June levels. The German and Japanese equivalents are deeper into negative territory. A negative government bond yield means that you have to pay the government to lend it money.

The US 10-year bond yield is almost unchanged over the same period but is extremely low by historic standards.

But, importantly, low macroeconomic volatility and easy monetary policy are incentivising another global search for yield among investors.

This has coincided with improving sentiment towards emerging markets, which are showing nascent evidence of stabilising growth and inflation.

This has led to a surge in emerging-market portfolio inflows, declining government bond yields and stronger exchange rates.

South Africa has benefited. In recent weeks, there has been a surge in portfolio investment supporting both the domestic equity and fixed-income markets. South African government bond yields have subsequently declined. The benchmark R186 was just above 8.6% last week, down from a peak of 9.8% in late January.

The rand has also strengthened against most major currencies. Compared to its weakest monthly levels recorded in January, it has strengthened by 11%, 19% and 9% against the dollar, the pound and the euro respectively. The South African economy is undergoing a protracted period of weak growth. This is partly due to exceptionally weak growth in domestic spending that is likely to continue due to government belt-tightening, low growth in credit extension to households, low consumer confidence and the impact of previous interest rate hikes.

Low spending growth means there is not too much money chasing too few goods reflected in core inflation, which remains well contained around 5.5% despite previous bouts of rand weakness.

Headline inflation is likely to increase further in the next few months, because domestic food and petrol prices will be higher during the second half of this year compared to the same period last year.

However, it will peak in December and decline steadily over the course of next year. This, coupled with the strengthening of the rand, weak domestic growth and downside risks to global growth, have reduced the scope for the Reserve Bank to hike rates further.

Nxedlana is FNB’s chief economist