Jeff Schultz, Senior Economist, BNP Paribas South Africa
- We have added another 25bp hike to South Africa’s 2021 policy rate profile.
- We expect the South African Reserve Bank (SARB) to tee up a gradual normalisation cycle at its July MPC meeting, hiking in both September and November and taking the end-2021 repo rate to 4.00%.
- Stickier non-core prices in H2, a possible lowering of the inflation target in 2022 and our view that the central bank’s output gap assumptions should gradually narrow, underpins our forecast tweak.
- With CPI set to slow below the SARB’s current implicit 4.5% target midpoint from Q2 2022, we see the policy rate ending 2022 at 4.75%, still below the pre- pandemic level.
Markets expect a 66bp pick up in Jibar in 2021 and another 127bp in 2022. Assuming 20bp for Jibar spread normalization, still means seven hikes are fully priced in against our expectation for five hikes in total. Hence, we do not see value in being paid in the front end. Our preference is to be long bonds through asset swap spread to position for a catch up to strong fiscal performance.
Our reading of the South African Reserve Bank’s (SARB) rhetoric in recent weeks is clear: rates cannot remain at record lows forever and the SARB favours starting policy normalisation in H2 2021 and not in 2022, as Reuters consensus estimates currently imply.
July MPC meeting to tee up hikes more formally: We expect the 22 July MPC statement to more formally lay the groundwork for interest rate hikes later this year.
We think this could come from at least one member of the five person committee favouring a rate hike in July, or via the committee’s quarterly projection model (QPM) and slightly faster closing output gap, implying a higher policy rate trajectory than the 57bp hikes by end-2021 suggested by the QPM in the May statement (Figure 1).
Some inflation upside materialising: While our upgraded H2 inflation trajectory (see South Africa: Moving on up, dated 10 June) has not changed, we think that some of the “upside risks” the SARB flagged to its own CPI estimates in the May MPC meeting have materialised.
We expect the SARB to make upward revisions to its USD62/bbl Brent crude oil assumptions in its models, while the trends in global food prices suggest that we have not yet seen the peak in domestic food CPI (though ZAR strength has helped; Figure 2).
A gradual normalisation path
Sticky CPI in H2: Our above consensus estimate for CPI to average 5.0% in H2 2021 indicates that inflation will temporarily struggle to fall back to the SARB’s implicit 4.5% midpoint target for the remainder of this year (see South Africa: Moving on up, dated 10 June). Importantly, though, we see CPI falling back below target from Q2 2022 (Figure 3).
More elevated food prices coupled with our expectation for tighter global oil supply balances pushing Brent crude prices up towards USD80/bbl by year-end underpin our thinking (see Oil market to tighten further – Brent likely to breach USD80/bbl, dated 21 June). However, we maintain that core price pressures should remain well behaved, thanks to lower wage growth (though the SARB could view the latest above CPI offer for public wages – mainly due to a “cash gratuity” – as a potential upside risk), lack of rental price impetus (supply and demand) and a better behaved ZAR (see South Africa GDP deflator reinforces core CPI view, dated 18 March).
Inflation expectations likely bottomed in Q1: We expect the release of the BER’s Q2 inflation expectations report in conjunction with next week’s MPC statement to highlight that expectations bottomed in Q1, with a small pick-up likely. Nevertheless, the numbers are still likely to show that medium-term expectations are anchored toward the target midpoint (Figure 4).
Thinking ahead to a lower inflation target in 2022:
Indications from the SARB Governor that the National Treasury (in consultation with the central bank) is looking to review the country’s inflation target range (lower from the current 3-6%) also matter for the future reaction function of the SARB, we think. While discussions are at a “very early stage” and a change is probably only likely in 2022, this does not prevent MPC members from thinking ahead to this eventuality, we think. A lowering (and narrowing) of the target range to 2-4%, we think would be favoured by the SARB Governor and Finance Minister, Tito Mboweni – the latter a well-known inflation ‘hawk’. Though a narrower 3-5% band may be more politically palatable, we believe.
Normalisation coming: In line with a number of EM central banks, we think that the SARB’s July MPC statement is likely to provide the clearest indication yet that a gradual normalisation path is coming. The notion that the central bank needs to hike quickly for fear of falling behind other EM central banks is partly misguided, in our view though, given that South Africa’s ex-post real policy rate spread with its EM peers still looks favourable, despite more aggressive hikes already delivered by comparable peers (Figure 5).
September hike loading: We attach only a 20% chance of a hike being delivered on 22 July. Near-term economic concerns related to the violent protests that have gripped the country this week and the country still in the midst of its third Covid-19 wave that has resulted in the imposition of ‘Level 4’ restrictions, mean that the central bank is still in a position to keep a cool head next week. We expect SARB’s strategy will be to flag its intensions regarding monetary policy normalisation.
We add an additional 25bp hike to our policy rate profile for 2021, expecting incremental hikes in both September and November. We also maintain our forecast for 75bp in cumulative hikes in 2022, taking our end-2022 policy rate estimate to 4.75%, still below pre-pandemic levels and hence still viewed by SARB as “accommodative.”