MPC preview: Interest rate cut – not “if”, but “by how much”

Article by Lullu Krugel Chief Economist for PwC Strategy&, and Dr Christie Viljoen, PwC Strategy& Economist

No emergency MPC meeting was necessary

The South African Reserve Bank (SARB) Monetary Policy Committee (MPC) gathers for its next bi-monthly meeting on March 17-19. An earlier (emergency) meeting was not considered: SARB Governor Lesetja Kganyago said on March 3 that there is no need to call an emergency MPC meeting in response to the fallout from the coronavirus disease 2019 (COVID-19). He added that the central bank was busy assessing how the situation would impact on the South African economy and, based on this assessment, the central bank will take appropriate action at its next meeting.

Prior to the COVID-19 panic, there were already expectations that the central bank could lower interest rates further in 2020. The MPC announced at its previous meeting in January a 0.25 percentage points cut in interest rates on the back of significant reductions in its inflation forecasts. Policymakers also noted that the implied path of interest rates generated by their Quarterly Projection Model indicated scope for another 25 basis points cut later in the year. This was largely due to low inflation and also a weak economic climate.

Re-forecasting the (favourable) inflation outlook

The SARB’s inflation outlook was quite favourable in January. The central bank was happy with the moderation in headline inflation towards the middle of the 3%-6% target range and indicated in January it expects average inflation of 4.7% and 4.6% in 2020 and 2021, respectively. A survey by the Bureau for Economic Research (BER) showed that analysts, businesspeople and trade union officials were expecting slightly higher averages for the two years – though their expectations were much lower than the near-6% predictions seen not too long ago.

Recent developments have seen a large dive in the international oil price as well as a sharp depreciation in the rand exchange rate. Both were partially influenced by panic around COVID-19 and the impact thereof of the global economy. A lower oil price is quickly associated with some fuel price relief for local consumers. The potential benefit on inflation is certainly tempered by a weaker rand – the South African currency’s current level around R16/$ is notably higher than the R14.60/$ seen at the last MPC meeting. The SARB will take into account these dynamics when it re-forecasts inflation.

Sharply deteriorating economic growth outlook

The MPC said in January that it expects economic growth of 1.2% in 2020 – this was before the recession was confirmed. January seems like a long time ago given the volume of domestic and international developments over the parts two months. A long list of downside risks has since materialised, including data confirming a recession in 2019H2; the COVID-19 panic’s impact on international trade, supply chains and consumer demand; a Budget Speech 2020 providing no real solutions to the fiscal situation, and a weaker exchange rate due to worries over global growth, amongst other issues.

These risks have resulted in the deterioration of the growth outlook for 2020-2021. Moody’s Investors Service, for example, cut its growth forecast for this year from a previous 0.7% (announced on February 17) to just 0.4%. Moody’s – the only ratings agency still giving South Africa and investment-grade rating – linked this directly to the impact of COVID-19 on both supply and demand dynamics in global trade amongst major developed and emerging markets. We believe that the SARB will definitely cut its growth forecast next week. It could be a significant cut.

Other central banks have already cut rates

The Organisation for Economic Co-operation and Development (OECD) commented on March 2 that the impact of the pandemic could – under a wider contagion scenario – reduce global economic growth by up to a half this year. South Africa is seeing significant pressure on the business climate in many of its major trading partners as the movement and gathering of people are severely restricted in major global cities.

A deterioration in many countries’ growth prospects have resulted in multiple central banks cutting interest rates in recent weeks. Monetary authorities like the US Federal Reserve, Bank of Canada, Reserve Bank of Australia and Bank Indonesia, amongst others, have cut lending rates in response to the adverse economic impact of the COVID-19 fallout. (This gives South Africa room to also ease monetary policy based on interest rate differential considerations.) Many countries have also resorted to other steps aimed at boosting liquidity in financial markets and the banking sector.

A repo rate cut of more than 25 bps would be justified

It is unlikely that the South African economy will in the first quarter of this year bounce back with a bang from the 2019H2 recession. The IHS Markit South Africa Purchasing Managers Index (PMI) indicated that February 2020 was the tenth consecutive month of contraction in private sector activity. In other words, the decline in private economic activity during the second half of last year continued into 2020Q1 so far.

Kganyago has said many times – most recently in a speech on March 4 – that easier monetary policy is not a solution to South Africa’s economic growth challengers. Instead, the central bank is advocating structural reforms to the economy that encourages saving, attracts investment, increases exports, and raises “exceptionally low” productivity growth. He is correct in this long-standing argument – lower interest rates are not the answer to long-term growth challenges.

However, easier monetary policy can certainly provide a short-term boost. The SARB has previously commented that a 25 basis points cut in the repo rate could lift GDP growth by 0.1 percentage points over a 12 to 18 month period. At this stage, that increase in growth prospects will be very welcome. The SARB will publish its latest growth projections this week and these numbers are unlikely to be encouraging. Moody’s Investors Service, for example, is currently looking at growth of only 0.4% this year. The SARB’s forecasts will likely not be far off that number.

We believe that, despite no need for an emergency MPC meeting earlier this month, this is an urgent enough situation to warrant an interest rate cut of 50 basis points. This could even be spread out: two 25 bps cuts in March and May, respectively, would suggest the SARB is not in panic mode. Significant monetary policy easing – combined with faster implementation of economic reforms, as indicated in the Budget Review 2020 – is required to boost the South African economy. This could add 0.3 percentage points to economic growth over the next 12 months. And there is no risk to the inflation outlook from this suggested stimulus.

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