Lesetja Kganyago, Governor of the South African Reserve Bank.
Waldo Swiegers / Bloomberg via Getty Images
The South African Reserve Bank has fired the starting gun for normalizing monetary policy, but economists do not expect the walking cycle to be normal.
On Thursday, the SARB raised its primary repo rate by 25 basis points to 3.75% from its record low level amid growing concern about upward inflation risks. The central bank raised its forecast for the consumer price index from 4.4% to 4.5% in 2021 and from 4.2% to 4.3% in 2022.
The increase marks the first step in settling 275 basis points of cuts made since the start of the Covid-19 pandemic, but the Monetary Policy Committee split its vote 3-2, indicating conflicting sentiment in the SARB as it appears to support the recovery , while counteracting inflation fears.
Total inflation in the consumer price index was modest 0.2% month-on-month in October, an annual increase of 5%.
In his statement, SARB Governor Lesetja Kganyago noted that rising oil and energy prices pose upside risks to the short-term inflation outlook.
Jeff Gable, head of macro and interest rate analysis at South African bank Absa, told CNBC on Friday that the rise in the repo rate had come a little earlier than many economists had expected, showing the bank’s concern about upside risks to inflation. Projections, however, remain around the center of SARB’s targets so far.
“We know that in South Africa we have tens of millions of vulnerable South Africans who are not really able to protect themselves from inflation, and so [we have] a reserve bank here that has had to talk hard about inflation throughout the cycle, “Gable said.
“So this signal, this first price increase a little earlier than we expected, is definitely an indication, I think they want to stay on top of it.”
A gradual walking cycle
Gable said it remains to be seen whether the winding up of SARB’s accommodating position will come in successive political meetings, or whether the market will be in tension every time MPC rallies over the next few years.
Virag Forizs, emerging markets economist at Capital Economics, said in a note on Thursday that the decision indicates a slower tightening cycle than the markets had expected.
Kganyago said the MPC believes that a “gradual increase in the repo rate will be sufficient to keep inflation expectations well anchored and moderate the future interest rate path.”
“This pigeon skew probably helps explain why the rand was initially weakened against the dollar after the decision,” Forizs said.
“In addition, MPC members are likely to want to keep monetary policy as accommodating as possible in order to continue to support the economy.”
Capital Economics has drawn 150 basis points over the next two years, with the repo rate rising to 4.5% by the end of 2022 and to 5.25% by the end of 2023.
In contrast, Forizs highlighted, the market is pricing around 250 basis points for increases over the next 18 months.
Growth prospects unclear
The economic recovery has so far been stony. Covid lockdown measures and pockets of civil unrest have weighed on activity at various points over the past two years.
While the SARB expects annual GDP growth of 5.3% in 2021, it has lowered its 2022 projection sharply from 2.3% to 1.7% and in 2023 from 2.4% to 1.8%.
What’s more, the country is struggling to implement fundamental economic reforms after years of sluggish growth. Education, infrastructure, labor, public sector wages and the privatization of state-owned enterprises are all on the table in the discussions.
South African President Cyril Ramaphosa will visit the Coronavirus Disease Treatment Facilities (COVID-19) at the NASREC Expo Center in Johannesburg, South Africa on 24 April 2020.
Jerome Delay | Reuters
Gable noted, however, that divisions within the ruling ANC party have caused a “logjam” that has made progress difficult.
“A South Africa that grows 1.75 to 2% in the medium term is not a South Africa that is growing fast enough to create meaningful changes in the social challenges of the country, the inequality in the country,” he said.
“So we would expect, I suppose, an increase in tensions, a heightened pressure for change, but still this concern about where the agreement is about what direction the broader change should take.”
Conflicting views on the brink
JPMorgan on Friday lowered its position on the South African rand to “underweight” from “middleweight”, citing its vulnerability to rising core bond yields.
“In South Africa, 2021 was a year of largely ‘good news’ – we see more risks in 2022, with currency most exposed,” said JPMorgan’s emerging markets strategists.
They noted that weakening support from terms of trade – a measure of a country’s export prices relative to its import prices – has pushed the dollar back to its highest levels from year to date against the rand. As of Friday afternoon, the dollar would buy around 15.73 rands.
JPMorgan sees the possibility of further weaknesses, where the current account – which represents a country’s imports and exports of goods and services – is expected to deteriorate in 2022.
As of September, South Africa’s balance of payments surplus rose to a record high of 343 billion rand ($ 21.8 billion) on the back of a stronger trading account and record high exports of goods.
However, Gable disagreed with this forecast, suggesting that the tailwind from the country’s balance of payments surplus will be more sustainable than expected.
“Part of [the surplus] due to the fact that commodity prices have been favorable. The mix of commodity price movements over the last few months has been a bit less beneficial for South Africa, but it does not diminish the surplus that we expect to run going forward, “Gable said.
“It should broadly provide support for the fringe, even in an environment where the world globally may be turning a little more towards the new markets.”
Absa expects a gradual weakening of the rand on a trend basis over the next two years, from a starting point in late 2021 at “somewhere in the early 15s to the dollar.”