SARB keeps repo rate unchanged; interest rate bias to the upside

By Kevin Lings*

The South African Reserve Bank, once-again, decided to leave the Repo rate (Repurchase Rate) unchanged at 3.50% at its MPC meeting today. The decision was unanimous. The Reserve Bank last adjusted interest rates on 23 July 2020, when they cut the Repo rate by 25bps. Since the beginning of 2020 the Repo rate has been reduced by a total of 300bps. South Africa prime interest rate remains unchanged at 7.0%.

In essence, the MPC still expects inflation to be contained in 2021, before rising to around the midpoint of the inflation target range in 2022 and 2023. At the same time the SA economy is expected to continue to recover, albeit at a still fairly moderate pace, which suggests that SA GDP will only return to its pre-covid level in 2023. Importantly, the Reserve Bank has made it clear that the interest rate bias is to the upside, mainly because SA is likely to continue to experience negative real interest rates, which creates downside risks for the Rand – especially if the United States starts to scale-back its current monetary policy stimulus.

In announcing the decision to leave interest rates unchanged, the SARB made a number of important points regarding the outlook for SA economic growth as well as their inflation forecast:

In terms of inflation the Reserve Bank highlighted the following:

• At a global level, a wide range of prices is accelerating, from raw materials to intermediate inputs to food, reflecting both global supply shortages and rising demand.
• A stronger exchange rate, ongoing moderation in unit labour costs, and sustained economic slack are expected to offset higher electricity and food price inflation.
• The SA inflation forecast for 2021 is slightly lower at 4.2% (down from 4.3%) and for 2022 and 2023 unchanged at 4.4% and 4.5%, respectively.
• Expectations of future inflation have broadly stabilised at around 4.0% for 2021 and 4.2% for 2022.

In terms of the growth outlook the Bank highlighted the following:

• As indicated by South Africa’s public health authorities, a third wave of virus infection is probable in the near future.
• Household spending is expected to be healthy this year, in line with the easing of lockdown restrictions and low interest rates. Getting back to pre-pandemic output levels, however, will take time.
• Fixed investment activity, while stabilising, remains constrained.
• The Bank’s forecast for South Africa’s first quarter growth stands at 2.7%, much stronger than the 0.2% contraction expected at the time of the March meeting. The economy is expected to grow by 4.2% in 2021 (up from 3.8%).
• GDP is expected to grow by 2.3% in 2022 and by 2.4% in 2023, little changed since the March meeting.
• Slow progress on vaccinations, limited energy supply and policy uncertainty continue to pose downside risks to growth.
• Important macroeconomic gains would be realised by achieving a stable public debt level, increasing the supply of energy, moderating administered price inflation and keeping wage inflation low into the recovery.

The implied policy rate path of the Reserve Bank’s Quarterly Projection Model (QPM) indicates an increase of 25 basis points in each of the second and fourth quarters of 2021. This, together with the latest MPC statement confirm that SA reached the bottom of the interest rate cycle during 2020 and that the path for interest rates is currently biased to the upside.

In conclusion, the Reserve Bank cut the Repo by a total of 300bps in 2020, which amounts to almost a halving of the Bank’s reference interest rate during the COVID-19 crisis. That can be considered a fairly aggressive reduction in interest rates. Furthermore, the Repo rate has been kept unchanged for almost 11 months despite the economy starting to experience negative real rates with inflation surprisingly more recently to the upside. It is also fair to argue that during this phase, inflation expectations have become anchored around the mid-point of the inflation target, which is a very welcome outcome. Lastly, although the bias to SA interest rates are to the upside, it appears likely that the Reserve Bank will try to avoid undue tightening of monetary policy, while at the same time remaining mindful of the current upward drift in inflation as well as the currency risks SA would most likely experience should the United States start to withdraw its current highly accommodative monetary policy.

• Kevin Lings is chief economist at Stanlib.