The South African Reserve Bank (SARB) raised the repo rate more than expected on Thursday, 21 July, by 75 basis points to 5.5%. The South African Reserve Bank (SARB) raised the repo rate more than expected on Thursday, 21 July, by 75 basis points to 5.5%. The hike marked the fifth meeting in which the central bank’s Monetary Policy Committee (MPC) raised rates.
“Three members of the Committee preferred the announced increase. One member preferred a 100 basis points increase. Another member preferred a 50 basis point increase,” said SARB Governor Lesetja Kganyago at the announcement.
The increase comes as the central bank battles to keep a lid on inflation, on which he said “the Bank’s forecast of headline inflation for this year is revised higher to 6.5% (from 5.9%). Higher food, fuel, and core inflation are expected to keep headline inflation elevated at 5.7% in 2023 (up from 5%). Headline inflation of 4.7% is expected in 2024, unchanged since the May meeting.”
Investment professionals share views on the central bank’s substantial hike and how the move could impact various asset classes
Ashburton Investments: SARB move likely to be very supportive of SA Government Bonds
Our initial impression from today’s SARB meeting was as hawkish as we could possibly have anticipated. The SARB MPC today made history by deciding to hike the repo rate by 75bp from 4.75% to 5.5%. This marks largest hike by the SARB since the Tito Mboweni SARB increased the policy rate by 100bp increments in the 2002/2003 cycle when the repo rate was still in double digit territory, recalls Michael Grobler, Fixed Income Strategist at Ashburton Investments.
He says given the current base level of rates the 75bp increment hike can be classified as a outsized hike. “This decision came against market consensus of 50bp hike within the economist community. The FRA market, however, was accurate with the 1×4 FRA pricing a hike of 75bp magnitude ahead of the meeting.”
“As a result we saw Rand appreciation with USDZAR moving -0.5% on the day, but SA Government Bonds stole the limelight as the bond curve flattened very aggressively due to the market applauding the action as a noteworthy decision to get ahead of domestic inflationary pressures.”
The R2035s out to bonds maturing in 2048 rallied close to 30bp on the day to post over +2.4% returns. We anticipate that the SARB opted for a larger hike to front-load against rising inflation expectations survey from BER and rising inflation forecast profile from their QPM model, says Grobler.
He says this move is likely to be very supportive of SA Government Bonds and the rand into month end when we will also see an increase in SA weight in the JPM GBI EM index and R41bn of coupon payments lend additional support to bruised bond investors.
SARB feels pressure to out-hawk the Fed Matrix Fund Managers, says Carmen Nel, Economist and Macro Strategist, Matrix Fund Managers
While this was larger than the consensus median, it was not entirely surprising given that the market had been assigning a reasonable probability to such an outcome. That said, the statement and the voting split – with one of the Monetary Policy Committee (MPC) members voting for a 100bp hike – were clearly hawkish. As such, a 75bp increase at the next MPC meeting should not be ruled out.
We think the key factors that led to the relatively large increment were:
- More hawkish global monetary policy, with the Fed having moved by 75bp at the June FOMC meeting;
- The weaker rand exchange rate, not only versus the US dollar but more broadly based on the circa 6% depreciation in the trade-weighted rand since the May meeting;
- The sharp increase in inflation expectations, particularly for the 5-year horizon; and
- Elevated wage settlements and the risk of inflation persistence at the core level.
While we had expected the SARB to be more sensitive to the fragile domestic growth backdrop, the bank is firmly focused on inflation and ensuring its credibility remains intact. Today’s outcome and the recent inflation data highlight that South Africa is a price-taker on global financial conditions and fuel and food price dynamics.
Given that the inflation peak in the rest of the world is not yet in the base, the SARB is set to continue to front-load policy tightening, which would imply that the neutral rate of 7.00% (as per the Bank’s model) could be reached much sooner than implied by the bank’s own forecast. This would still be below the 8.00% – 8.50% level implied by the forward rate agreements (FRAs), which are assigning a substantial risk premium in light of the highly uncertain outlook.
A more aggressive hiking cycle than currently projected would most likely require further substantial and sustained rand weakness, capital flow volatility, and a large deterioration in SA-specific factors. A sustained higher global cost of capital and a strong dollar would be headwinds to growth, but could keep inflation elevated via a weak rand.
The Fed Funds futures market is already pricing in rate cuts from the Federal Open Market Committee (FOMC) by mid-2023. If global policy does stabilise in early 2023 and ultimately reverses course, even if only partially, then it will give the SARB some breathing room. Until then, the central bank will have to ensure that the real policy rate (the nominal repo rate adjusted for inflation) steadily rises, joining all the other central banks that have been trying to out-hawk the Fed.
The larger-than-expected increase resulted in a sharp flattening in the FRA curve, but a more moderate move in the yield curve. While the rand tracked the US dollar index for most of the day, the more hawkish policy stance supported the rand in late trade with the rand 0.7% stronger on the day (with the dollar index flat at the time of writing). The impact on the equity market was limited, with retailers slightly down on the news, while the banks benefited.
PPS remains constructive on domestic bonds, says Luigi Marinus, Portfolio Manager at PPS Investments
Inflation is expected to moderate from the current level to 6.0% this year and 5.6% next year. However, market surveys are predicting higher inflation than the SARB’s forecast at 6.5%. At PPS we remain constructive on domestic bonds with allocations to nominal and inflation-linked bonds as the steep yield curve still provides adequate compensation for the inherent risk.Luigi Marinus, Portfolio Manager at PPS Investments