South Africa Faces Tough Call as It Decides Rates Today

South Africa which remained mired in a weak growth environment, with inflation threatening to increase further is expected to tighten monetary policy when it’s Monetary Policy Committee (MPC) rises from its statutory meeting today.
‘We expect a 25bps rate hike at the May MPC meeting, in line with the anticipated deterioration in inflation between April and early-2015. Given that inflation is likely to continue to rise – extending the breach of the inflation target – a further 25bps tightening in July is plausible’, said Razia Khan, analyst on Africa at Standard Chartered Bank, London.
Should the SARB fail to tighten today, a 50bps rate hike in July may become necessary in order for the central bank to reassert its anti-inflation credentials, she said. 
But by then, headline CPI inflation may be at much higher levels, closer to seven percent than the upper level of the 3-6 percent target, and much damage would have been done to the central bank’s credibility as regards inflation targeting. We believe that with the SARB in tightening mode, the preference will still be to act early and shape expectations. 
Even with a 25 basis points (bps) hike, the real repo rate will remain negative, and policy will still be accommodative. But the weight given to price stability – even in a difficult environment – will be clear.
He first quarter, 2014 Gross Domestic Product (GDP) growth (data to be released next week) is likely to have been negligible. Mining almost certainly experienced an outright contraction, following protracted industrial action now into its 17th week. Some platinum mines have reported the loss of as much as a third of their annual output as a result. 
Manufacturing output was likely negative on a q/q basis as well. Significant recovery is not expected until second half, 2014. Consumption expenditure is likely to have exhibited new weakness. It is unlikely to have offset the weakness elsewhere in the economy.
Admittedly, all of this makes for a particularly weak backdrop for further SARB tightening. However, the SARB has made clear that its mandate is price stability. Overly accommodative monetary policy cannot make up for structural problems in the economy, nor should past growth be a key driver of the policy decision. In its previous assessment, the SARB suggested some narrowing of South Africa’s negative output gap by 2015. Provided this remains the case, there may still be support for further tightening. Meaningfully, three of the seven MPC members voted for a tightening at the last MPC meeting in March. This was despite a downward revision of growth projections at the time.
Many interpret the publicising of the 4-3 vote to keep interest rates unchanged at the last meeting as a deliberate communication to prepare the market for further tightening. Indeed, the SARB has emphasised that it is in a tightening cycle. MPC members have also emphasised that they would want any competitiveness benefit from a potentially weaker ZAR to be ‘real’, not to be whittled away by rising prices. is the SARB’s own emphasis on anchoring inflation expectations that leads us to expect a modest tightening now.
There is some risk, however, that with the ZAR not under any immediate pressure, and with demand weak and characterised by ‘lustreless’ credit extension to households, that the SARB holds off on any tightening. Under such a scenario, even with the breach of the inflation target, it would hold off on any tightening until it is put to further test by the markets. In our view, this is not the most likely outcome, as it would run counter to the communication already provided by the SARB. Given the circumstances, however, it is difficult to exclude entirely.

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