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SA interest rates could see biggest hike since 2016 this week

Source: Fin24, 20/05/2022

Jeff Schultz expects the SA Reserve Bank will front-load the rate hike cycle with two increases of 50 basis points each in both May and July as it attempts to ensure that inflation falls back towards 4.5%.
We expect the SA Reserve Bank (SARB) to hike its policy rate by 50 basis points �` its largest hike since January 2016 �` to 4.75% on Thursday. While high levels of uncertainty and a weak South African economy suggest that the decision is unlikely to be unanimous, we expect a stronger majority (4:1) than before to be in favour of front-loading hikes.
The SARB is unlikely to make large adjustments to its growth or output gap estimates presented in its March forecasts, although it could revise down slightly its 2.0% 2022 GDP growth forecast in response to the April floods in KwaZulu-Natal and resultant damage to infrastructure and port delays.
SARB could also lower its bullish 3%-of-GDP current account surplus forecast for this year for the same reason. However, we don’t expect this, or the recent step-up in load shedding, to influence the SARB’s decision next week �` the focus right now is probably on anchoring inflation and inflation expectations.
CPI inflation averaged 5.8% year-on-year in the first quarter, in line with the SARB’s March estimate. In addition, a major private medical insurance provider has further delayed a premium increase to October (from May previously) and a temporary reduction in fuel levies has been introduced for April and May.
However, such developments are only likely to change the shape of the SARB’s inflation profile, not its forecast peak. SARB previously forecast the inflation rate to peak at 6.2% in the second quarter and average 5.8% in 2022 versus the BNP Paribas forecast of 6.2%.
The SARB’s own estimates of local supply chain difficulties have spiked to a record high, oil prices remain high and volatile (above the SARB’s $103 per barrel assumption for 2022) and the rand has come under renewed downward pressure as a result of global monetary policy tightening and concomitant growth and commodity price concerns.
SARB had a starting point of R15.41/dollar in March, whereas the pair is currently trading above 16.10).
We view the SARB’s assumptions on food inflation as conservative (average of 6.1% pencilled in for 2022 - versus the BNP Paribas forecast of 7.6%).
Global food price inflation (as compiled by the Food and Agriculture Organisation of the United Nations) has surged and could rise further as a result of the impact of the Russia�`Ukraine war. Given the three-to-four month lagged effect that this has on domestic agricultural product prices and up to three-to-three-month lag on CPI food prices, we believe that the SARB will have to raise its food inflation forecasts next week.
In addition to rising supply-side pressures on inflation, our in-house `core-core` indicator of output gap sensitive prices rose above Stats SA’s traditional core measure in March for the first time since May 2018. This suggests services price inflation �` to which our indicator is more heavily weighted �` is building momentum.
Wage pressure
Wage negotiations currently include above-inflation wage demands in both the private and public sector. Higher settlements that are not matched by productivity gains are inflationary and a key upside risk to inflation.
Our analysis by major sectors shows that, after being held back by low wage increases last year, unit labour costs, particularly in the tertiary sector, have already started to rise sharply as productivity and underlying growth momentum slow.
Faced with materialising upward risks to the inflation outlook, and with the US Federal Reserve now likely to deliver four consecutive 50 basis point hikes into September, we believe that a strong majority on the five-member monetary policy committee will vote in favour of front-loading the rate hike cycle in both May and July (50bp hikes) as the SARB attempts to ensure a fall in inflation and inflation expectations back towards its 4.5% midpoint target next year (we do not expect inflation to fall back to target until the fourth quarter of 2023).
We maintain our above-consensus call for the policy rate to end 2022 at 5.75% and be raised to 6.50% by mid-2023 as the SARB looks to build up room for manoeuvre in a highly uncertain global environment.
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