SA approaching end of rate-hiking cycle

TWO weeks ago, we learnt that GDP growth had surprised on the upside, improving to an annualised 3.3% in the second quarter of this year compared to the first.

However, when compared to the same period last year, secondquarter growth was only 0.6%. GDP is up only 0.3% for the first six months of the year compared to the same period last year.

Growth is weak and will most likely stay weak, given government belt-tightening, weak employment and credit extension, and low consumer and business confidence. The latter is impairing private fixed investment, domestic production and export growth.

The Reserve Bank’s latest growth forecasts reflect this. Growth for 2016 was revised up from a very weak 0% to a still weak 0.4%. The bank expects the economy to grow by 1.2% and 1.6% respectively in 2017 and 2018. Should growth remain below 2% in 2019, the five-year period to 2019 will be one of the weakest since the end of World War 2.

The one silver lining to weak growth is that it has kept core inflation, which excludes volatile items such as food and energy prices, relatively well contained below 6%.

By contrast, there has been severe upward pressure on headline inflation for most of this year. The main drivers have been the drought-induced increase in food prices and a domestic petrol price that has perhaps been higher than it should have been. The high domestic petrol price is due to a rand exchange rate that has at times been far weaker than what was justified by the fundamentals.

However, inflation outcomes have been far better than what the Reserve Bank expected, with August inflation being within its inflation target for the first time in eight months.

The better-than-expected outcomes are increasingly reflected in Reserve Bank forecasts. The bank has revised its inflation forecasts downwards and now expects headline inflation to average 6.4% this year and 5.8% next year. Core inflation is now forecast to average 5.7% this year and 5.6% next year.

This is a long way from the expectation that headline inflation would average about 7% this year and next, with core at 6% over the same period.

There are two main risks to the improved inflation outlook, although they are probably now more benign.

First, while the Reserve Bank expects a meaningful moderation in food inflation over the course of next year, this is contingent on expectations of normalisation in rainfall, which is not guaranteed.

Second, although the risk to inflation posed by the rand has declined, the rand level assumed in the Reserve Bank’s inflation projection is weaker than the current rate, and the impact of the rand on the broader price level has been muted.

However, there are concerns that

Inflation outcomes have been far better than what the Reserve Bank expected

the factors driving the current bout of rand strength may be temporary and that the rand remains vulnerable to US Fed rate hikes and the ebb and flow of domestic political arrangements.

The bank has signalled that to the extent that its current expectations of persistently weak growth and less-problematic inflation are met, further rate hikes are unlikely.

The question that follows is whether rate cuts are imminent. Guidance from the bank on that score is that the bar for cuts is high. This implies that inflation would probably have to decline by more than expected to invite rate cuts.

We are most likely in a period of an extended pause in interest rates. This is not a bad outcome in the context of weak growth coupled with the various shocks, both internal and external, that the South African economy has suffered.

Nxedlana is FNB chief economist