Real rates, based on SARB's forecasts

• The SARB was a little less hawkish yesterday than at the previous MPC meeting. The bank’s inflation forecasts (4.9% for 2018, and 5.4% for 2019) are somewhat higher than ours which are 4.4% and 4.8% respectively. Further, the bank assesses the risks to the upside. While the bank’s headline inflation forecasts are not strongly pointing to further monetary easing, it is very encouraging that the SARB’s core inflation forecasts are lower: 4.6% for 2018, and 5.1% for 2019.
• The forward-looking real repo rate calculated, using the SARB’s core rather than headline inflation forecasts, is already higher than the level that the SARB’s actions in recent years implied the bank is comfortable with, and also exceeds the SARB’s estimate that the current neutral real rate is around 1.5%.
• We foresee that the SARB’s inflation forecasts may have to be lowered further to compel the MPC to cut interest rates. We see scope for two 25 bps rate cuts in 2018. Critically, this would depend on the inflation trajectory, and the key risk to that is the rand exchange rate.

Note: see graph on real rates below.

Daily commentary

Rand view: As we had expected, the SARB kept the repo rate unchanged at 6.75% yesterday. After the SARB’s MPC announcement, the SAGB curve steepened, and the USDZAR rallied to highs last seen in 2015. The rand is now comfortably trading in our 12.00-12.20 range for Q1:18. Crucial for both the rand and the bond market will be significant events such as the Budget in February and Moody’s rating action for SA in March. Further, the rand will remain sensitive to politics.

SARB MPC meeting yesterday less hawkish; risks remain, but scope for cuts

The members preferring an interest rate cut (while still in the minority) increased from zero to one. The SARB’s inflation forecasts are lower, and the rate hikes forecast by the SARB’s Quarterly Projection Model are less hawkish (the third hike now only marginal, and generally pushed out). They did highlight event risk around growth and the Budget as well as the conclusion of the Moody’s rating review after the Budget. We suspect that the SARB’s inflation forecasts may have to be lowered further to compel the MPC to cut interest rates (see chart of the day).

S&P’s take on downgrade risk

S&P has said that while SA’s ratings are safe for this year, the key risks as to why SA was downgraded to non-investment grade in November are still very much at play. These include growth underperformance, rising debt-to-GDP levels, and underperformance of SOEs such as Eskom. These are driven by SA not focusing on structural reforms, especially in the labour market and key sectors such as mining. Regarding SOEs, Eskom is in danger of defaulting, as liquidity issues are concerning. Further, higher education funding will be watched in the upcoming Budget. A positive is that the private sector could assist in creating jobs given the political turnaround. Further, it is possible for SA to make its way back to investment grade if these issues are addressed but it would take an average of 7-8 years.

In our published note 2018 SA economic outlook of11 January 2018, we highlighted the debt trajectory of different combinations of additional spending on tertiary education for the poor, using both the R12-15bn estimate widely reported in the media as well as Treasury’s estimate of the cost of free TVET college education for all students and 50% of university students. The potential impact of free tertiary education to the poor on government’s debt (level and stabilisation) is striking. Even a low estimate of only R12bn (that keeps pace with inflation) would weaken the fiscal position noticeably (debt levels above 60% by 2020, even with growth at 2.5%).

US developments: after a fight broke out in the US House of Representatives yesterday, the current legislation to provide funding for government operations has been left hanging, and a government shutdown this weekend might not be avoided. There is still a chance that negotiations will take place to resolve it; the dollar will be on the defensive.

China’s Q4:17 GDP has come in stronger than expected, at 6.8% y/y, from 6.7% y/y predominantly because of a rebound in the industrial sector, strong property demand, and export growth. Further, YTD growth was 6.9%, in line with 2016.

Latest research publications:

SA Macroeconomics: MPC for January 2018 by Elna Moolman (18 January 2018)

Credit Quant Note: Secondary market: Quarterly by Varushka Singh (18 January 2018)

SA Economics: Nov retail sales 8.2% y/y by Thanda Sithole (17 January 2018)

Africa Flash Note: Nigeria: inflation surprises to the downside as the MPC is unlikely to meet this month by Ayomide Mejabi (16 January 2018)

African Sovereign Eurobond Weekly: African Eurobonds: No changes in overall composition of the portfolio by Dmitry Shishkin (15 January 2018)

SA Macroeconomics: Macro Weekly by Elna Moolman (15 January 2018)

Credit Weekly: Repo rate cuts expected by Robyn MacLennan, Steffen Kriel and Varushka Singh (12 January 2018)

SA Macroeconomics: 2018 SA economic outlook by Elna Moolman (11 January 2018)

SA Macroeconomics: Rand outlook by Elna Moolman (10 January 2018)

Credit Special Report: Eskom update by Steffen Kriel (10 January 2018)

SA Macroeconomics: Economic Insight by Elna Moolman (9 January 2018)

SA Economics: Dec vehicle sales -2.4% y/y by Thanda Sithole (9 January 2018)

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