There are two big worries for the SA economy: that inflation continues to overshoot, and that commodity prices tumble. As the global economy takes a turn for the worse both fears are being realised, with troubling implications for SA’s growth and fiscal outlook.
Last week SA’s May consumer price index (CPI) came in at 6.5%, against consensus expectations of 6.1% — a large overshoot. It wasn’t entirely unexpected though, given that inflation also overshot in the US and Europe in May.
Global inflation is turning out to be a far larger problem than expected. The fear is that once inflation becomes this entrenched it may take a recession to bring it to heel.
The fact that the upside surprise to domestic CPI in May came mostly from food, and that inflation pressures are becoming more broad-based, will make the Reserve Bank even more jittery about the outlook for inflation expectations and wage demands.
The upshot is that another 50 basis point hike is almost guaranteed at the Bank’s July monetary policy committee (MPC) meeting. It will probably be unanimous, and the committee may even debate whether to follow the US Federal Reserve (Fed) with a 75 basis point hike.
RMB strategist John Cairns thinks that while a 75 basis point hike is neither likely nor necessary in SA, the pressure on the Fed to hike more aggressively is reverberating in SA. The Bank will be mindful of the need to maintain SA’s interest rate differential with the US and to protect its inflation-fighting credibility.
As the pressure builds on central banks to hike more aggressively, so the risk of a policy mistake grows. As such, fears are building that the US economy could be headed for a recession. And if the US slows, everybody slows.
The combination of the war in Ukraine, the Fed’s hawkish pivot and China’s Covid-19-related slowdown have clouded the global growth outlook, causing commodity prices to come off their recent highs. So much so that Cairns is becoming worried for the rand.
“There’s nothing to panic about yet,” he says, “commodity prices are still decent”. But with commodity prices turning less favourable for SA, he is starting to fear that the bias has shifted towards rand weakness.
Absa currency strategist Mike Keenan certainly doesn’t expect the rand to trade below R15/$ again in 2022. For that to happen the growth environment would have to become exceptionally positive again.
What happens to the rand in the second half of the year depends largely on whether global risk aversion improves, which in turn hinges on what kind of a slowdown the Fed manages to engineer. How aggressively the Reserve Bank hikes is also key.
The market is pricing almost 300 basis points in rate hikes in SA over the coming year, which would put the repo rate at 7.65%, from 4.75% now. Most economists feel this is a bit alarmist and put the terminal rate at 6.25%-6.5%. Still, a few months ago most thought the Bank would have to hike to only 5.25% by year end.
Keenan puts the rand’s fair value at R15.40/$, so it’s trading closer to R16/$ is largely due to global risk aversion. Therefore, though there is a lot of risk out there, much of it is already in the price. He expects the rand to end the year at R15.75/$, but it could also go above R16/$ if risk aversion intensifies.
In short, the situation is extremely volatile and downside risks to SA’s growth and fiscal outlook are starting to materialise, with worrying implications for social stability.
It is unfortunate that the next six months are going to be politically fraught as President Cyril Ramaphosa fights to secure a second term, since the Bank may have little choice but to hike into stagflationary conditions to maintain its credibility and anchor inflation expectations.
The combination of political and economic instability is likely to stretch SA’s social fabric to breaking point. Brace for a bumpy ride.
• Bisseker is a Financial Mail assistant editor.
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