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May 2021 – SARB's Monetary Policy Committee (MPC) Announcement Pre-commentary

It would be no surprise if the SARB Monetary Policy Committee (MPC) members unanimously decide to leave the bank’s repo rate unchanged at 3.5% per year this week. But, of equal importance will be the tone of the bank’s statement as market participants look for clues as to the likely future path of the bank’s policy interest rate.

The real repo rate is currently negative and monetary policy is accommodative. But, growth is lifting, the negative output gap (surplus capacity in the economy) is narrowing, and higher consumer price inflation of close to 4.5% is forecasted for 2022. If expectations for the economy over the next 12 months are realised, the bank is likely to shift towards a less accommodative stance as we head into 2022.

Indeed, the implied policy rate path of the bank’s Quarterly Projection Model (QPM) shows the repo rate at 4.00% at the end of 2021 (with increases of 25bp each in the second and fourth quarters of this year) and 4.95% at the end 2022.

But, the MPC members are only guided, not bound, by the QPM’s implied policy rate path. And, considering current information, the interest rate hiking cycle seems likely to be “delayed”, perhaps to next year.

Admittedly there are risks, not least of which is increasing US inflation and what this may imply for the medium-term US monetary policy outlook. At present, the US Federal Open Market Committee is comfortable with the view that the nascent bounce in inflation is temporary. Suppose that changes and expectations of the timing of US monetary policy tightening are brought forward. In that case, the likely negative impact on global financial conditions can be expected to permeate through to South African interest rate expectations. However, assuming global supply disruptions, including supply-chain blockages, begin to dissipate as pandemic related economic restrictions ease and global trade increases, it seems reasonable to expect lower US inflation in 2022.

And, locally, even though an export commodity price boom has boosted local income and purchasing power, the economic recovery is yet to be firmly established. One of the missing ingredients from the recipe for a sustained domestic business cycle upswing is firm credit extension. There is modest growth in household credit extension, reflecting instalment sales and mortgage advances. However, credit extended to corporates is decidedly weak. As a result, total seasonally adjusted credit extended to the private sector was just 1.5% higher in March 2021, compared with the average level for the three months prior to March 2020. Total seasonally adjusted loans and advances (excluding investments and bills) increased by a mere 0.2% over the same period.

By cutting interest rates, the MPC aims, amongst other objectives, to encourage borrowing and support domestic demand. But, currently, credit extension is far from robust, and the economy is a long way from overheating.

Another key consideration is inflation expectations, which have remained well anchored. The inflation expectations survey of the Bureau for Economic Research (BER), which the SARB MPC considers in its deliberations, has shown inflation expectations for the medium term are anchored just below the mid-point of the bank’s inflation target range for 2022 and 2023.

In addition, South Africa is a small, open economy, and the rand plays a significant role in inflation outcomes and expectations. Accordingly, the marked appreciation of the currency over the past year should go some way towards containing inflation.

Ultimately, forecasting the future is fraught with risk, but while these conditions persist, the bank can afford to bide its time.

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