South Africa still in a tightening cycle

The South African Reserve Bank (SARB) today raised its policy rate by 50bp to 6.75%, as a result of a significant deterioration in the inflation outlook due mainly to the weakening of the ZAR. Despite a weak growth outlook, risks to inflation remain unfavourable, and we expect the SARB to gradually continue its tightening cycle this year. The ZAR remains vulnerable in the near term.

The South African Reserve Bank (SARB) today raised its policy rate by 50bp to 6.75%, and kept a relatively hawkish tone. The SARB was widely expected to raise rates, but consensus was split between a 25bp and a 50bp hike.

"We expected a 25bp hike, as the growth outlook remains very weak. The MPC was split in its vote, with three members voting for a 50bp hike, two members voting for 25bp and one voting for unchanged rates. This reflects the MPC's worries that higher rates will add to the significant pressures facing the South African economy", says Nordea Bank.

The hike was a result of the deteriorating inflation outlook since the last meeting, caused mainly by the sharp weakening of the ZAR and higher food prices. Inflation expectations have increased since the last meeting in November and the MPC said it will continue to keep a close look on the development of expectations. The SARB increased its inflation forecast to expect headline inflation to average 6.8% in 2016 (vs earlier 6%), and it now expects inflation to breach the upper band of the target of 3-6% for most of 2016 and 2017.

The MPC expressed the risks to inflation as balanced. However, economists see risks to inflation as tilted to the upside. Further weakening of the ZAR remain the primary upside risks. Other risks stem from possibilities of further hikes of electricity tariffs due to the electricity shortage and above-inflation wage increases.

Higher inflation but a weak growth outlook tilted to the downside is a dilemma the MPC is facing in making its decisions. The economic growth forecasts were revised lower to 0.9% for 2016 (prior 1.5%) and 1.6% in 2017 (2.1%). However, although the MPC says it remain vigilant to any negative impact on cyclical growth from monetary policy actions, it sees the growth constraints as mainly of a structural nature which cannot be solved solely by monetary policy.

 "We expect weakening pressure to remain on the ZAR in the near-term until oil prices stabilise and volatility eases. Weak domestic fundamentals will continue to make the ZAR especially vulnerable in the current environment with low risk appetite. Beyond the near term we expect modest strengthening as EM sentiment improves and commodity prices stabilize", added Nordea Bank.