A drop in consumer inflation to its lowest level in almost nine years may open the window for the Reserve Bank to surprise financial markets and cut interest rates, providing relief to a struggling economy.
Underscoring weak demand in the domestic economy, the rate of increase in consumer prices, as gauged by the annual change in the consumer price index (CPI), slowed to 3.7% in October, down from 4.1% in September. These levels have not been seen since February 2011, Stats SA said.
The reading takes the average for the year so far to 4.2%, compared with the 5.5% the Bank was predicting a year ago.
While this increasingly benign inflation landscape provides Bank governor Lesetja Kganyago a window to cut rates on Thursday, economists say that the Bank’s hand could be stayed by the country’s deteriorating fiscal position and the threat of further credit-ratings downgrades, which could weaken the rand and cause a spike in inflation.
Political attack
The Bank has come under political attack from elements in the ANC alliance who say it does not do enough to support an economy that the government expects to grow only 0.5% in 2019 and has an unemployment rate of close to 30%.
Market reaction to Wednesday’s inflation report was muted, signalling a view that a cut in rates is not imminent. "From every angle it seems to me there is scope for the Reserve Bank to cut interest rates," said Elna Moolman, head of SA macroeconomic, fixed-income and currency research at Standard Bank. "There is no evidence of demand driven inflation," said Moolman, who said she expected average inflation to be near the 4.5% midpoint of the target range in 2020.
The "only possible reason" it would not ease policy on Thursday would be concern about a shock to the rand after the 2020-2021 budget in February, which may be followed by a downgrade from Moody’s Investors Service if the government fails to show enough progress in stabilising its debt and supporting growth, she said.
After falling as much as 0.7% on Wednesday to its weakest level since November 14, driven mainly by waning hopes for a trade truce between China and the US, the rand recovered its losses and ended the day barely changed. It was at R14.7730/$ by 5.05pm, leaving it with a 3% drop so far in 2019. It was also little changed at R16.3638/€ and traded at R19.0977/£.
Bonds were slightly firmer with the yield on the R2030 security, which moves inversely to the price, down two basis points at 9.05%. Fixed-income products benefit from lower interest rates because that boosts the relative value of coupons paid out to investors.
Bonds "did not suggest there is a risk of an interest-rate cut imminently," said FNB Wealth and Investments portfolio manager Kabelo Tshola. "It would be ideal for a rate cut to happen because that would stimulate an element of consumption growth, but then there is that overhang of what if we cut too early and all of a sudden we get downgraded and the rand blows out."
The Bank cut the repo rate only once in 2019, by 25-basis points in July, despite inflation surprising on the downside as policymakers focus on survey data showing inflation accelerating towards the upper end of the 3%-6% target range in 2020.
Most economists polled by Bloomberg expect the bank to keep the repo rate on hold at 6.5%. While the favourable inflation outlook and "dismal economic growth prospects" could justify further monetary policy loosening on Thursday, this will be a "close call", given the Bank’s other issues of concern, said Elize Kruger, senior economist at NKC African Economics. After October’s medium-term budget policy statement outlined a severe deterioration in SA’s fiscal position, ratings agency Moody’s changed its outlook on the country’s credit rating from stable to negative.
Moody’s is the last ratings agency to class SA debt at investment grade. A loss of that status would see the country falling off key indices that foreign investors use as benchmarks, potentially leading to billions of rand leaving the country as they offload SA bonds.
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