Monetary Policy Statement

* The Reserve Bank’s Monetary Policy Committee (MPC) raised the repo rate to 5,75% from 5,50%.

* The inflation outlook has deteriorated marginally since the last MPC meeting.

* Inflation is projected to peak in the fourth quarter of 2014 and return to within the band in the second quarter of 2015.

* The MPC statement again highlighted the committee’s dilemma of trying to counter increased inflation risks against the background of a weakening economy. The decision to raise interest rates by 0,25 percentage points is therefore a compromise. The MPC again reiterated that interest rates are in a rising cycle and that at some point they will have to be ‘normalised’. The implication is that the MPC will continue to talk tough but to act as moderately as possible. The next hike will probably again be 0,25 percentage

points and will probably be in November. Our year end forecast for the repo rate therefore remains at 6% with a further rise to 7% taking place in the second half of 2015 when genuine interest rate hikes abroad force similar moves here.

Comment

The Reserve Bank’s Monetary Policy Committee (MPC) raised the repo rate to 5,75% from 5,50%. This was against our forecast of no change at this meeting but of gradual tightening later in the year. The Governor stated that although the MPC was concerned about weak growth, the widening output gap and the negative employment outlook, it would continue to gradually normalise interest rates, stressing that there was little monetary policy could do to mitigate the weak growth outlook. The Governor disclosed that the vote was six members of the MPC in favour of a hike and one in favour of no change. Of the six in favour of a hike, one argued for a 0,5 percentage points move while the rest were in favour of 0,25 percentage points.

The growth outlook has deteriorated, mainly due to domestic factors, since the May MPC meeting. The Reserve Bank has revised its gdp growth forecast to 1,7% (previously 2,1%) in 2014, 2,9% (previously 3,1%) in 2015 and 3,2% (previously 3,4%) in 2016. These forecasts are based on the expectation that the current labour strike in the steel and engineering sector will be resolved soon. The Governor stressed that prolonged work stoppages in these sectors would have a more pronounced impact on the economy than the five month platinum sector strike which ended in late June.

The outlook for inflation has worsened, albeit marginally, since the previous MPC meeting.

CPI is expected to peak at 6,6% in the fourth quarter of 2014, averaging 6,3% (previously 6,2%) in 2014. This is largely unchanged from the 6,5% peak in the fourth quarter of 2014 projected at the May MPC meeting. CPI is projected at 5,9% (previously 5,8%) in 2015 and 5,6% (previously 5,5%) in 2016. Core CPI is still expected to average 5,6%, 5,7% and 5,5% in 2014, 2015 and 2016 respectively. Risks to the inflation outlook remain to the upside, with the exchange rate of the rand remaining an upside risk. The rand has decoupled from its emerging market peers in recent months, reflecting unfavourable domestic developments, and should this continue the currency will remain under downward pressure.

The Governor once again highlighted the dangers to the outlook posed by high wage settlements, warning that a wage spiral could be set in motion as the recent high wage settlements in the mining sector and current demands in the metals sector pose a risk of setting a precedent for wage demands more generally.

Inflation expectations have remained anchored around the upper band of the inflation target band.

According to the Bureau for Economic Research’s second quarter Inflation Expectations Survey CPI is still expected to average 6,1% a year in 2014 and 2015. It will then ease marginally to 5,9% in 2016.

Other key points highlighted by the MPC were:

* There is still no evidence of demand-driven inflation pressures in the local economy.

* Financial analysts expect inflation to have reached a high point in this cycle at 6,4% in the second quarter of 2014 and to fall below 6,0% in the first quarter of 2015. It is projected to average 6,2% in 2014, 5,7% in 2015 and 5,5% in 2016

* Domestic wage pressures have risen. According to Andrew Levy Employment Publications the average wage settlement rate in collective bargaining agreements increased to 8,1% in the second quarter from 7,9% in the first quarter. However, unit labour costs increased by 4,8% in the first quarter of 2014 from 5,9% in the fourth quarter of 2013.

* Foreigners were net buyers of a cumulative R7,2 billion of local bonds and equities in the period since the previous MPC meeting and R44,2 billion since the January meeting.

Implications

The MPC statement again highlighted the committee’s dilemma of trying to counter increased inflation risks against the background of a weakening economy. The decision to raise interest rates by 0,25 percentage points is therefore a compromise, but even so an unfortunate one.

Much of the statement concentrated on the prevailing climate of weak demand and falling growth in credit demand, particularly to consumers. Given this, the committee is clearly aware that inflation is not demand driven and states so explicitly. By implication, interest rate rises can have very little effect other than to try and anchor the rand, but this is a futile task given the reasons for the currency’s weakness, which by the MPC’s own admission include policy uncertainty, labour unrest, but also economic weakness. Raising interest rates during a period of falling real credit demand therefore seems unlikely to quell inflation expectations and, worse, could be counterproductive.

The MPC has, however, again reiterated that the country is in a rising interest rate cycle and that at some point interest rates will have to be ‘normalised’, and that the ‘real repurchase rate remains slightly negative and well below its longer term neutral level’. This is clearly true. However, the true test of whether interest rates are too high or too low is whether banks are lending and customers are borrowing. Even with low interest rates this is currently not the case, in direct contrast to some of the early normalisers of interest rates elsewhere.

The implication is that the MPC will continue to talk tough but to act as moderately as possible. The next hike will probably again be 0,25 percentage points and will probably be in November.

Our year end forecast for the repo rate therefore remains at 6% with a further rise to 7% taking place in the second half in 2015 when interest rate rises in the developed world force similar moves here. Hopefully by then some of the structural reforms in line with the NDP referred to in the MPC statement (improved property rights, greater private sector participation and better policy predictability?) would have already been implemented, otherwise the economy will remain under pressure.

The Original Article

05 Aug 2015
Author Nedbank

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