The Reserve Bank’s decision on Thursday to leave interest rates on hold will not please those in the market who had expected the second 25 basis point cut in a cutting cycle that began with July’s monetary policy committee meeting.
The committee clearly had a robust debate, perhaps an unusually robust one, given that three of its members favoured a 25 basis point hike, with the remaining three preferring to hold. And on the numbers alone, it was surely a close call.
The Bank’s forecast for inflation is unchanged at 5.3% for 2017 and it has revised the forecast up only slightly to 5% and 5.3% in 2018 and 2019, with a lower turning point of 4.6% still expected in the first quarter of 2018.
Nor is the Bank fooled by the apparent bounce in the economy in the second quarter – it still expects very weak growth, with an updated forecast of 0.6% for this year, only slightly higher than the previous 0.5%, and no change to the forecasts for the next two years.
True, 5% is still above the mid-point of the inflation target range, and expectations, particularly of trade unionists, are nearer to 6% than to the 4.5% middle. So, SA was never going to see deep cuts in interest rates.
But the committee’s decisions are never just – or even mainly – about the numbers. They are, crucially, about how the members see the risks to inflation, largest of which is the vulnerability of the rand exchange rate.
And the major takeaway from Thursday’s meeting, a takeaway markets and policy makers should heed, is that those risks are now imminent, and substantial.
Looking at the landscape, it’s clear there are some key differences between July and now. The risk of a bad medium-term budget that could trigger a ratings downgrade, seems much higher now as evidence emerges of sizeable revenue shortfalls. The December elective conference is coming closer and contestation within the ANC is increasing rapidly.
The ratings agencies have held off from further downgrades, but it is not clear how long this will last. And, while SA and other emerging markets have had the benefit of global greed for yield, that could change, especially given this week’s US Federal Reserve meeting and the expectation that US interest rates will keep increasing.
But the rand is already sliding, and it is very vulnerable to adverse news globally and particularly locally
That’s the context for the committee’s carefully couched risk list, which is nonetheless quite disturbing. The committee spoke of a "deteriorating assessment of the balance of the risks" which drove its decision to keep rates on hold. It said "some of the event risks, particularly those of a political nature, are now more imminent but with no greater degree of clarity regarding the outcome".
It spoke, too, of the prospect of a further ratings downgrade, particularly given increased fiscal challenges and political uncertainty. It cited the global uncertainty about monetary tightening and capital flows.
In addition, it added a new upside risk – of a larger increase in electricity tariffs than the Bank has taken into account in its forecasts. If Eskom gets its way with the 20% increase it is demanding, this could add 0.2 to 0.3 percentage points to the forecast inflation rate, and could generate further "second round" effects on prices and wages.
As always, the committee will look again at the data and reassess at its next meeting, which is in November. That will be after the medium-term budget policy statement but before the next round of ratings updates and the ANC’s December conference, so certainty could still be elusive. But the rand is already sliding, and it is very vulnerable to adverse news globally and particularly locally.
It is possible SA may just have seen its shortest ever cutting cycle, and that the July cut may turn out to have been the only one. We have to hope that doesn’t prove to be the case.