Balancing act for Kganyago nixes rate cut

The Reserve Bank has scotched the idea that it was going to cut interest rates, warning that a likely pick-up in recently lower oil prices would reverse a significant decline in inflation and do nothing to boost economic growth, which was being constrained by electricity shortages.

Bank governor Lesetja Kganyago announced on Thursday that the monetary policy committee (MPC) had decided unanimously to keep the repo rate steady at 5.75% as lower inflation allowed a pause in its path of "normalising" or raising interest rates.

But he said: "The MPC is aware that the moderation in inflation could raise expectations of lower interest rates. The MPC is of the view that the bar for further accommodation remains high, and would require a sustained decline in the inflation rate and inflation expectations."

The bank predicts that due to the halving of oil prices over the past few months, inflation is likely to average 3.8% this year compared with a previous forecast of 5.3%, and sink to 3.5% in the second quarter of this year - near the bottom of its official 3%-6% target range.

But the MPC also believes that there will be a "moderate" oil-price rises over the next two years, and that this, along with a weak rand, will push inflation back up to 5.4% in 2016 - only a touch below its previous estimate of 5.5%.

"Unless a persistent oil-price decline is assumed, the impact on the inflation trajectory will dissipate over time," Kganyago said.

The key issue for the MPC was the extent to which "second-round" effects of inflation became evident and whether there was a further and sustained decline in inflation expectations - which, although lower, are still near the top of the target range.

Pay increases, particularly in the public sector, and the rand's volatile exchange rate, could worsen the inflation outlook, the MPC said, but the risks were "more or less balanced", with no evidence of excess demand pressures on inflation.

Nonetheless, analysts said the tone of the statement suggested that rate increases - which markets had expected earlier - were also off the table, at least in the near-term.

"We no longer expect rates to be raised this year, and expect only modest hikes in 2016," said John Ashbourne, the Africa economist at Capital Economics. He still believes the Bank will raise rates next year, albeit by a modest half a percentage point.

It hiked rates by 75 basis points last year in response to rising inflation - which peaked at 6.6% in May and June - and tighter monetary policy by the US Federal Reserve, which is expected to start raising rates in the second half of this year.

That is likely to trigger capital outflows from emerging markets such as South Africa, weakening the rand and the large current account deficit.

"Our conclusion is that rates are clearly on hold for a while," said Barclays Africa economist Peter Worthington.

"We continue to pencil in a 25basis point hike for September, but feel the risks are strongly tilted (towards) a later move, if the Fed's rate hike is delayed past mid-year or if the market reaction to the Fed hike is benign."

Speaking after the Bank's announcement, Kganyago said that in South Africa "real" interest rates - the difference between inflation and nominal interest rates - had effectively already been tightened, because of lower inflation.

The MPC slashed its growth forecasts for the economy, saying it was likely to expand 2.2% this year and 2.4% next year, compared with previous estimates of 2.5% and 2.9%, respectively.

"This forecast attempts to take account of electricity supply disruptions that more than offset the positive growth impact of lower oil prices."

MPC member Kuben Naidoo said at a press conference that lower interest rates would not stimulate the economy due to its inability to supply significantly more goods and services.