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Kevin Lings: Inflation caught Sarb’s Interest. Expect +0.75% more by year end.

The 50 basis point rate hike delivered by the South African Reserve Bank carried with it no surprises. The outlook for inflation was a concern, given the state of the weakened local currency, drought and political uncertainty, again no surprises. The growth was also downgraded to 0.9 percent for the year, slightly higher than the International Monetary Fund’s 0.7%, which is most likely the only slight surprise. The decision will also more than likely push the country over the recessionary cliff but can’t be seen as the primary reason for this. Stanlib chief economist Kevin Lings says the Reserve Bank seems to be significantly more concerned with inflation and expects the Repo Rate to end the year higher than 7.5 percent. That’s at least another 75 basis points for a consumer already under pressure to deal with, debt just got a lot more expensive. 2016 just got gloomier. – Stuart Lowman

By Kevin Lings*

The South African Reserve Bank opted to hike the Repo rate by 50bps to 6.75% at its MPC meeting today. This was in-line with market expectations (STANLIB +50bps). The Reserve Bank last adjusted interest rates in November 2015, when they increased rates by 25bps. The prime interest rate should now also be increased by 50bps. According to the MPC statement, the decision to keep rates unchanged was not unanimous. Three members supported a 50 basis point increase, two members preferred a 25 basis point increase, while one member preferred no change.

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In terms of inflation, the Reserve Bank indicated that the inflation outlook has deteriorated significantly, mainly due to exchange rate and food price developments.

  • The latest inflation forecast of the Bank shows a marked deterioration. Inflation is now expected to average 6.8% in 2016 and 7.0% in 2017. This compares with the previous forecast of 6.0% and 5.8%.
  • Inflation is still expected to breach the upper end of the target in the first quarter of 2016, but is now expected to remain outside the target for the entire forecast period.
  • A peak inflation rate of 7.8% is expected in the fourth quarter of 2016 and the first quarter of 2017, followed by a moderation to 6.2% in the final quarter of that year.
  • The changes in the forecast are mainly due to a significantly more depreciated real exchange rate assumption, and higher expected food price inflation.
  • These upward revisions more than offset the impact of the lower international oil price assumption.
  • The electricity price assumption remains unchanged from the previous meeting.
  • Core inflation is also expected to breach the upper end of the target range for four consecutive quarters from the third quarter of 2016, with a peak of 6.4% in the final quarter of 2016 and the first quarter of 2017.
  • The Reserve Bank will closely monitor changes in inflation expectations

In terms of the growth outlook the Bank highlighted that the economy remains weak, and made the following key points:

  • The global backdrop has also become more challenging particularly for emerging markets.
  • SA growth in 2015 is estimated to have averaged around 1.3%, and is expected to moderate to 0.9% in 2016, before accelerating to 1.6% in 2017.
  • The Bank’s estimate of potential output growth was revised down from 1.9% to 1.5% for 2016, and from 2.1% to 1.6% for 2017.
  • Although there was a marginal increase in the Bank’s leading business cycle indicator in November, the trend remains negative, consistent with the subdued outlook.
  • The RMB/BER business confidence index declined further in the fourth quarter of 2015, to its lowest level in five years.
  • The prospects for formal sector employment growth remains bleak

Overall, it is very clear that the Reserve Bank has become significantly more concerned that inflation will move well above the upper end of the target and then become entrenched at a higher average level. In making their interest rate decision the Bank made it clear that although  the economy has weakened significantly further, with risk to the downside, failure to act through and increase in interest rates could cause inflation expectations to become unanchored and generate second-round effects and more generalised inflation. Given the revised outlook for South Africa’s inflation rate, we think the SA Reserve Bank will continue to increase interest rates in 2016. At this stage we expect the Repo rate to end 2016 somewhat higher at 7.50%.

  • Kevin Lings is chief economist at Stanlib
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