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 "An interesting and positive article discussing the South African monetary policy for the future as outlined by governor Mboweni. " - Mark |
| South Africa: Back to the Future |
| By Riccardo Barbieri (London) |
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June 14, 2004 A more balanced MPC statement than in April. As was widely expected, the Monetary Policy Committee (MPC) of the South African Reserve Bank (SARB) left its repo rate unchanged at 8.0% at its June 9-10 meeting. The MPC statement was more balanced than the April one. In line with the recent Monetary Policy Review, it still offered a relatively optimistic assessment of the inflation outlook, but it strived to convey to the markets the idea that the SARB is entirely focused on the medium-term inflation outlook and believes that higher interest rates could be desirable moving forward. Effect of high oil prices hopefully transitory, but focus shifting to medium-term outlook. Consistent with the forecasts recently presented in the Review, the MPC argues that there is a risk that CPIX inflation, currently at 4.4%, will rise slightly above the top of the 3-6% inflation target in the final months of this year. However, the MPC believes that the overshoot would be temporary and that inflation will fall back within the target range over the course of next year. In turn, this suggests that the SARB hopes to ride out the spike in oil prices and the impending tightening in Fed policy without a rate hike, but will nevertheless raise interest rates if evidence mounts that the rise in inflation is persistent and/or that demand and cost pressures are likely to intensify over the course of 2005 and in 2006. Governor Mboweni sounded more hawkish, still seeming to favour a strong rand. In the press conference following the MPC meeting, SARB Governor Tito Mboweni made some off-the-cuff statements that sounded more hawkish to local market participants than the official MPC statement. According to Reuters, Mr. Mboweni argued that “the party is over” in terms of interest rate reductions: “Nobody should expect any more interest rate decreases.” Given that prior to the MPC the rand money market was pricing in almost 300 basis points of increase in the repo rate between now and the year-end, we believe Mr. Mboweni must have directed his comments to public opinion and the trade unions (which are currently negotiating wage contracts with employers) rather than to the financial markets. In our recent research trip to South Africa we did not find a single market economist or asset manager expecting a rate cut by the SARB! In trying to understand Mr. Mboweni’s motivations vis-à-vis the financial markets, we believe that -- in addition to adding a personal touch to the MPC statement -- the governor might have still wished to tactically prop up the rand exchange rate in order to offset the impact of high oil prices. Current monetary stance may not be appropriate if focusing on late 2005 and on 2006. Governor Mboweni added another comment that might reinforce the market’s expectation of rate hikes in late 2004 or in 2005 when he argued that “the further on one goes towards the end of 2005 and 2006, things become less clear in our [inflation] forecasts.'' The fact that the longer the forecast horizon, the greater the uncertainty, is hardly controversial. But what Mr. Mboweni seems to suggest is that he and the MPC are less sure that the current monetary policy stance will be appropriate as the cyclical expansion matures. According to the ‘fan chart’ in the recent Review, CPIX inflation should move below 6% over the course of 2005, albeit remaining in the upper half of the band. However, given that the SARB believes monetary policy exerts its full impact over a period of eighteen months, it will soon be time to focus on inflation developments further down the road. The SARB believes the current inflation picture is benign. In terms of the analysis of current inflation trends, the MPC statement takes stock of the recent acceleration in short-term inflation -- that is, in the quarter-on-quarter seasonally adjusted growth of the CPIX, which reached 7.2% in 1Q and 8.5% in April. However, it ascribes the acceleration to the recent rise in oil prices, to a hike in excise taxes on tobacco and alcohol, and to adjustments in administered prices. Furthermore, it expresses a positive view on food prices, which have moderated as the rains returned in the early months of the year and agricultural output recovered. Oil prices are the main near-term threat, but will probably decline in the medium term. A large increase in petrol prices went into effect in early June, following a more moderate one in early May. The forthcoming CPIX figures will be affected. The MPC argues that the recent announcement of an increase in OPEC production is good news, but “it is unclear whether prices will fall back fully to the OPEC target band.” However, “over the medium to longer term, oil demand and supply are expected to be more or less in balance, which could lead to a correction in international prices.” This is probably one of the reasons why the SARB baseline inflation forecast shows a gentle decline over the course of next year. Inflation expectations stay low … The quarterly BER inflation expectation survey was released as usual on the day of the MPC adjustment, and it showed unchanged expectations compared to the 1Q survey, with annual averages for the CPIX at 6.0% in 2004, 6.3% in 2005 and 6.4% in 2006. Importantly, the average prediction of trade union members was at 6.4% for both 2004 and 2005, and at 6.5% for 2006. In the previous survey, trade union members had predicted a CPIX rate of 6.1% in 2004, 6.4% in 2005 and 6.6% in 2006. The expectations of business people were unchanged, and those of market analysts declined for 2004 and were roughly the same (at 5.6%) for 2005 and 2006. The SARB thus seems to have been able to consolidate relatively low inflation expectations even though it has not been able to achieve a further decline. … but wage growth excessive. The MPC statement is considerably more critical than in April on the issue of labour costs. It notes that nominal labour costs “continued to increase at high rates” in 2003 and that “particularly disconcerting is the fact that nominal unit labour cost in manufacturing rose by as much as 11.2%,” raising concerns on its potential impact on domestic production prices. According to the MPC, “wage settlements in collective bargaining agreements are predicted to average between 7.5% and 8.5% for 2004.” “Although this indicates a declining trend when compared with the increase in labour remuneration per worker of about 9.5% in 2002, it is still considerably in excess of productivity increases.” There is nothing to add on this point other than the last statement must refer to remuneration in real terms (net of CPIX inflation). We stick to our expectation of higher repo rates, but believe the rise priced into the money market is excessive. Our existing South African forecast called for a 50 basis point increase in the repo rate (currently at 8.0%) at the October MPC meeting and then a further 100 basis points in 1H and 50 basis points in 2H 2005. Our view was predicated on the expectation of interest rate increases by the US Federal Reserve and, in due course, downward pressures on precious metals prices and the rand exchange rate. We also thought the SARB would move to a more forward-looking approach and focus on cyclical inflation risks and still-high wage growth in the medium term. We find that this assessment still reflects the balance of risks and the SARB’s renewed focus on the medium-term outlook. We have thus made only minor adjustments to it. If anything, we feel that if the SARB moved pre-emptively, it might be able to limit the overall increase in the repo rate to no more than 150 basis points between now and end-2005. On a 24-month view, 200 basis points of cumulative rate hikes is still our baseline scenario, and we believe the 300 basis points of tightening that the money market is pricing in over that time frame are excessive. Reference: Morgan Stanley website 
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