SARB rate cut – unexpected timing
The South African Reserve Bank cut the repo rate by a further 100 basis points to 4.25% by unanimous decision at its unexpected Monetary Policy Committee meeting today.
- In a bold move today, the SARB cut the repo rate by a further 100bps to 4.25% in an unexpected MPC meeting.
- The STANLIB Fixed Income team welcomes the rate cut in the interest of its impact on stimulating much-needed economic activity
- There remains room for further rate cuts going forward given the low inflationary environment and outlook
- Credit risk has risen back to 2008 levels and about R100bn of local assets have been sold by non-resident investors
- The SARB stressed that monetary policy cannot, on its own, improve the potential growth rate of the economy or reduce fiscal risks.
The South African Reserve Bank (SARB) last adjusted interest rates on 19 March 2020, when it cut the repurchase rate (repo rate) by 100 basis points (bps). This followed a cut of 25bps on 16 January 2020 and a cut of 25bps in July 2019.
While the timing of the latest interest rate cut was not expected, since it occurred at a non-scheduled MPC meeting, the market was expecting the SARB to cut rates significantly over the coming months.
Victor Mphaphuli, Head of STANLIB’s Fixed Income team welcomes the recent rate cut by SARB as it will help stimulate the economy during these difficult times. “Increased economic and consumer activity will assist in spurring the economy and potentially limit downgrades, but the latter is largely dependent on government implementing reforms. If we can demonstrate willingness to do this, it can eventually be positive for the bond market in the long term,” he said.
It can still be argued that the SARB has scope to cut interest rates further, especially considering the current trend in global interest rates (see chart below), as well as the SARB’s expectation that inflation will remain largely under control despite recent currency weakness.
Global policy interest rates – Developed versus emerging markets
In announcing the rate cut, the SARB made a number of important points regarding its inflation forecast and the outlook for South Africa’s economic growth.
In terms of inflation the SARB highlighted the following:
- Slightly lower oil prices and sharply lower domestic growth have moderated the inflation forecast
- Weaker inflation outcomes in the near term are, however, likely to give way to higher inflation later in the forecast period
- The SARB’s headline consumer price inflation forecast averages 3.6% for 2020, 4.5% for 2021, and 4. 4% in 2022. The overall risk to the inflation outlook at this time appears to be to the downside
- International food prices have eased and local food price inflation is expected to remain low, in part due to higher domestic production levels
- Electricity pricing remains a concern, but has moderated somewhat
- Risks to inflation from recent currency depreciation are expected to be muted as pass-through is slow
- Barring severe and persistent currency and oil shocks, inflation is expected to be well contained, remaining below the midpoint of the target in 2020 and close to the midpoint in 2021
In terms of the growth outlook the SARB highlighted the following:
- Globally, economic contractions are expected to be deepest in the second quarter of 2020, with some recovery expected in the third quarter of the year
- The strength of the global economic recovery into the fourth quarter and 2021 will depend on how quickly countries are able to open up for economic activity safely
- Current indications from the World Health Organization are that the pandemic is unlikely to end quickly, with shorter, less virulent waves hitting over time
- The COVID-19 outbreak will have a major health and social impact, and forecasting domestic economic activity presents unprecedented uncertainty. With that in mind, the SARB expects GDP in 2020 to contract by 6.1%, compared to the -0.2% expected just three weeks ago. GDP is expected to grow by 2.2% in 2021 and by 2.7% in 2022.
In terms of concerns about market liquidity, the SARB noted, that while advanced economies conduct exceptionally accommodative policies, global financing conditions are no longer supportive of emerging market currency and asset values. Credit risk has risen back to 2008 levels and about R100bn of local assets have been sold by non-resident investors. The SARB, however, argued that they have taken steps to ensure adequate liquidity in money and government bond markets and to ease capital requirements to free capital for on-lending by financial institutions.
Lastly, the SARB stressed that monetary policy cannot, on its own, improve the potential growth rate of the economy or reduce fiscal risks. These should be addressed by implementing prudent macroeconomic policies and structural reforms that lower costs generally, and increase investment opportunities, growth potential and job creation. Such steps will further reduce existing constraints on monetary policy and its transmission to lending.
In conclusion, while the timing of the MPC decision was unexpected, the policy response seems entirely appropriate given global and local economic developments. It seems clear that the severe impact of COVID-19 on the SA economy and financial markets (which will obviously be accentuated by the President’s decision to extend the duration of the lockdown), prompted the SARB to continue to cut interest rates aggressively. The additional 100bps cut in rates should help to mitigate the current fall-off in household and business confidence, improve some of the liquidity constraints in the market and cushion some of the financial constraints now plaguing many households as well as small and medium-sized businesses. However, it is certainly not a cure for the weakening economy.