The Reserve Bank’s monetary policy committee (MPC) could remain in limbo for the rest of the year and keep interest rates unchanged.
The committee, which will have two more meetings this year, will have to weigh a volatile exchange rate and a slight rebound in the economy against looser global monetary policy — a combination which could see them play it safe.
The MPC cut interest rates by 25 basis points (bps) last month, effectively reversing a controversial interest-rate hike in November 2018. The Bank cited lower growth and lower inflation expectations for the cut. While some analysts called for a 50 bps cut at the time, the MPC said it did not consider it.
Now, analysts are speculating that the Bank won’t make another move this year.
The forward rate agreement market, which had priced in a rate cut for September, has reassessed the path of interest rates as less dovish and is now pricing in no material chance of a rate cut until January 2020 — with only about a 40% chance of a 25bps cut then.
The major central banks have adopted easier monetary policy stances, with the US Fed cutting its federal funds rate by 25bps in July. In sharp contrast, the rand has weakened significantly. The rand has breached R15/$ reaching its worst level in 11 months. The currency’s one-week implied volatility is the highest among major currencies at 16.72% on Friday, its highest volatility since March, according to Bloomberg.
While this is partially due to SA’s wide current account deficit, which leaves the country vulnerable to external shocks such as escalating global trade tensions that cause investors to pull back from riskier assets, the rand has also been hit by growing concerns about Eskom’s severe financial woes and the implication of this for government’s already onerous debt burden.
“Given these counterbalancing forces, we believe the MPC will err on the side of caution, leaving interest rates unchanged for an extended period,” Nedbank economist Johannes Khosa said.
Problems at Eskom are expected to continue while divisions within the ruling party will prevent President Cyril Ramaphosa from pushing through the reforms that saw the rand strengthen when he was first appointed, Capital Economics economist John Ashbourne said.
Tensions between the US and China are also unlikely to ease anytime soon while slower global growth could see the price of SA’s key commodity exports trend down, he said. “The pressure on the rand probably won’t let up anytime soon,” Ashbourne said.
Currency weakness is likely to add to potential inflationary pressures, which will contain the amount of easing that the Bank can “reasonably” deliver, said head of emerging markets strategy at TD Securities Cristian Maggio.
“Given the current circumstances, a forecast for at most one cut this year is still somewhat reasonable, though risks are leaning more towards the November than September meeting,” he said.
Added to this uncertainty is an expected ratings announcement from Moody’s Investors Service in November. Moody’s, the last credit rating agency that has SA above investment grade, has already taken a grim view on the bailout to Eskom. On Thursday, the ratings agency said government had little room for additional support to Eskom which would result in a larger fiscal deficit and higher debt burden.
The rand’s recent underperformance indicates that the market is already pricing in a downgrade by Moody’s to at least a negative outlook, Standard Bank currency trader Warrick Butler said.
“The timing of the [next MPC] decision is too close to the Moody’s decision date. The MPC may want to wait for that outcome before deciding on the path to take. There’s no point cutting rates if we are downgraded because the bond and FX will need help,” Butler said.
While growth prospects for the year still remain dim, a recovery in the economy will give the MPC room to leave rates unchanged. After a steep contraction in the first quarter of the year, the economy is expected to rebound in the second quarter – helping SA avert its second recession in two years. Barring the agricultural and construction sectors, the rest of the economy is expected to have recovered. The GDP figures for the second quarter will be released on September 3, two weeks before the MPC is set to meet again.
“Signs of a recovery in the second quarter have increased the risk that policymakers will leave their key rate on hold at 6.50% in September, rather than cutting as currently expected,” Ashbourne said.
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