Economic Thoughts: A Very Thoughtful SARB

A very thoughtful SARB last Wednesday left interest rates unchanged, though maintaining a policy normalisation prospect, meaning a rising interest rate trajectory.


Its reasoning was well considered.


Risks to the global outlook have increased, when considering a slowing Chinese economy. These risks, along with continued EM capital outflows, have increased global market volatility & encouraged the Fed to delay liftoff. This delay of itself further added uncertainty to an already volatile global mix (for which reason spirited Fed speeches as to true intentions for most of last week?).


SARB notes the deteriorating domestic outlook, but describes the 2Q15 GDP contraction as a ‘surprise’. This surprised reaction of itself is unsurprising, since the demand side of the economy (as estimated by SARB) did not show a contraction. The contraction occurred on the supply (production) side (as estimated by StatsSA) and clearly came as a surprise to SARB.


This reference to 2Q15 being a surprise was repeated more than once in the MPC statement. It clearly had an impact.


As the production side is taken as definitive, a residual item of -2.2% of GDP was invoked to bring demand in line with less buoyant production. This makes the rest of us none the wiser as to what really transpired in 2Q15.


Either production has been underestimated in 2Q15, or SARB has reason to be surprised about its own demand estimates. Or both.


Be that as it may (a favourite Bernanke argument closer). Back to what matters.


The Rand depreciated significantly since the last SARB monetary policy meeting in response to stuff happening. This for SARB intensifies the upside risks to our inflation outlook.


Sharply slowing growth & rising inflation risks poses a dilemma for SARB. The former suggests policy hands-off, the latter demands higher interest rates. It was resolved (unanimously) for now to stand back & do nothing (copying the Fed).


CPI inflation was 5% in July, falling to 4.6% in August, mainly because of petrol price declines. Core inflation fell to 5.3% from 5.8% in early 2015.


SARB now forecasts 4.7% average inflation for 2015, with a peak of 6.7% in 1Q16, then dropping back towards the target zone, before peaking again at 6.2% in 4Q16. Most of this 2016 peaking is due to low oil base effects a year earlier. For 2017 inflation is again trending below 6% (but then who really knows what will happen to the world, oil & Rand in the interim deciding that?).


More significantly, core inflation is seen as 5.4% in 2016 & 5.3% in 2017, both comfortably inside the target range.


Inflation expectations as surveyed makes you wonder who knows best where inflation will travel – market analysts, labour unionists, business people or the SARB model? Relevant is that these expectations remain anchored.


Back to the bigger world shaping us decisively.


SARB describes the global outlook as having become more uncertain, in part due to market reactions to the deteriorating Chinese outlook. US growth prospects remain positive but clouded by possible spillbacks from slowing EMs, especially China, and the strong Dollar.


Fear of an abrupt Chinese slowdown has been fuelled by excess property & industrial capacity. Equity market volatility, surprise Yuan devaluation & uncertain policy responses added fuel to such concerns.


The actual Chinese slowdown to date has been moderate. But a hard landing could impact badly on global markets, especially on commodity prices.


These events further clouded the prospects of commodity producers & EMs with close trade links to China. Deteriorating terms of trade (export prices falling faster than import prices) have compounded the impact of ongoing EM capital outflows in anticipation of US monetary policy normalisation.


EM growth forecasts have been further lowered nearly everywhere.


Falling commodity prices have assisted global inflation lower, although some EMs with falling currencies are seeing higher inflation.


US concerns about its growth being restrained by a rising Dollar, global market volatility & risk of a sharp EM slowdown kept the Fed on hold this month. The ECB & BoJ may undertake further monetary easing.


Clearly, the world has turned cautious, and not without reason, considering China & volatile global markets.


The Rand, too, got caught in these cross-fires, fluctuating in a range of 12.60 to 14:$ since the last SARB meeting, yet its trend depreciation this past year hasn’t been all that different from its (many) peers. So relax. We are in good company, not being singled out (as some other people – Brazil – clearly are).


The Rand was badly hit by Chinese events, ever more intense speculation about Fed liftoff & the weaker-than-expected surprise 2Q15 SA GDP outcome. The Rand, like so many others, reacted well to the Fed decision to hold off on liftoff. Also, our narrower current account deficit at 3.1% of GDP pleased many (but one wonders how many appreciate its temporary nature?).


Even so, all this strengthens the impression that when the Fed does do liftoff (Dec15, anyone?), the Rand will weaken again. The extent is uncertain, but allow for a temporary overshoot as volatility rises sharply.


As to the current account deficit, aside of its temporary 2Q15 contraction, both export & import volumes are responding to Rand weakness & weaker economy. SARB feels this adjustment process may remain slow as a slowing global economy, electricity shortfalls & tourism disruption aren’t helpful.


SARB downgraded its growth forecast, not least because of the 2Q15 GDP surprise contraction. SARB then stresses that it considers a further 3Q15 GDP contraction unlikely (presumably again from the demand side, or this time also from the output side?).


Even so, SARB describes the outlook as weak (how about “grim”?) amid declining business & consumer confidence.


SARB lowered its GDP forecast to 1.5% (2015), 1.6% (2016) & 2.1% (2017). It then pronounced the risks to the growth outlook as more or less balanced (but presumably time will tell?).


The growth disappointment to date has been especially evident in the goods-producing sectors, with contractions in agriculture, mining & manufacturing. Service sector growth also moderated.


Agriculture remains constrained by drought. Mining output rose in July, but commodity price prospects are poor (still sliding), global demand lower & there is (high) risk of gold & coal strikes. Manufacturing output also rose minimally in July, but the Barclays PMI fell below 50 in August, with further declines in capacity utilization (both bad omens?).


Fixed investment has been weak, as business confidence fell to its lowest level since 2011. This doesn’t bode well for job growth (indeed more job losses are expected?).


Households are also subdued, with retail sales only marginally advancing in recent months as retailer business confidence fell sharply. The motor trade is in recession, with new car sales in 3Q15 falling 8% yoy.


Consumers will be constrained by job losses, eroding disposable income growth & rising inflation. Real credit to households keeps shrinking due to tighter affordability criteria, with household deleveraging continuing, debt-to-income falling to 77% (the lowest since 2006).


Average nominal wage growth is seen continuing above inflation. Also, food price acceleration is a concern as drought impacts. Oil price declines offer some respite, with oil prices hopefully contained in the short to medium term. SARB has downgraded its oil price assumption, with risk to the downside, though with any Rand weakness acting as spoiler.


Adding all that up, SARB remains concerned about the inflation outlook, with risks to the upside. The two 6% target breaches in 2016 are seen as temporary and due to low oil price base effects.


Be that as it may. Longer term, the inflation trend remains uncomfortably close to the upper end of the 3%-6% target range. Given upside risks, probability of more extended target breach is high. A sustained breach could unhinge inflation expectations which for now remain sticky at the upper target range.


SARB is of course also concerned about domestic growth prospects, likely to remain constrained by global events, uncertainty & volatility, low business & consumer confidence & electricity shortfalls.


SARB, however, also remains mindful of second-round effects of supply-side shocks on inflation. The prime risk is the Rand, likely to react further to Fed liftoff. Also, more risk from higher multi-year increases in electricity tariffs from mid-2016 (after the municipal elections….).


Downside inflation risk comes from oil (hopefully) & continuing weak domestic demand (for certain?).


Still, SARB sees overall risks to the inflation outlook as on the upside. In striving for a fine balance between realising its core mandate (constraining inflation) and not undermining growth unduly, it kept rates unchanged for now.


But SARB remains on a gradual policy normalisation path (echoing the Fed). If the risks to the inflation outlook were to deteriorate materially, it would not hesitate to act appropriately.


For this reason everyone still expects one 0.25% rate hike. With Fed liftoff likely in Dec15, SARB might follow in Jan16. And after that, along with the Fed, go on hold. Thereafter, all depends on whether our inflation & its expectations keep hugging the upper target limit.


Full SARB policy normalisation would suggest a real repo rate of 1%-2%. At 6% nominal repo, we are barely real now, so over the next three years have at least 1%-2% interest rate lifting to go if the SA economy normalizes, too, but much will depend on the world, on the Fed, our growth, the Rand & much more. Inflation especially.


Keep tuned. This is a never-ending journey.