The SARB MPC shocked markets by keeping rates unchanged at 6.75%, despite strong market pricing and survey expectations for a cut, but taking a step back, this was the right decision. The decision rotated on just one member’s switched vote and then the Governor’s deciding vote. While we see rates unchanged now through the forecast horizon, the outlook for 2018 looks quite bimodal depending on the political/fiscal/ratings risk nexus, with hikes or cuts possible.
After a 4-2 vote to cut rates at the July meeting, we went into this meeting expecting the four doves to take the opportunity of strong market pricing and survey expectations to undertake another ‘opportunistic cut.’ Indeed, three doves still thought that way and decided to cut rates, even with the inflation risk balance shifting to the upside. In our opinion, they were still clearly wedded to a more benign view of the risk outlook, both on ratings and on inflation, etc. They have shown some consistency and we believe view this as a cycle (indeed the double meeting vote would seem to indicate this). The two consistent hawks also have a clear framework – patience, waiting for risk events to pass before thinking about cutting rates, concerns about the where expectations are and focusing now on the upside skew in the inflation risks.
This meeting, however, pivoted from the last on one member switching sides – clearly not viewing this as an immediate cycle, preferring to wait for the impact of their last cut (but a 25bp cut has minimal impact and we don’t believe the doves would have started a cut at the last meeting just with 25bp in mind) or maybe becoming more concerned and more patient on waiting for risk events with such a busy Q4 coming up (but this was known at the last meeting) – even with market pricing ‘allowing’ a cut.
With two consistent camps, we choose to focus on the marginal vote. But what we struggle with is that in reality very little has changed in the global or domestic risk backdrops – especially with benign market pricing. Very marginal shifts in the CPI and GDP forecasts have occurred – in particular around the key 5% long run level for inflation that we saw as a key trigger. But in reality, it seems difficult to see how a cut at the last meeting could be justified but then not today – unless such small shifts in CPI, the Fed, the orderly and not significant move in ZAR – were the deciding factors.
Fig. 1: SARB forecast shifts
Source: SARB, Nomura
As such, we got a 3-3 vote with the Governor’s casting vote taking us over the line to a cut. While no surprise that the Governor is a key hawk, the confirmation is still gratifying given the use of the deciding vote. We think this is probably the first time this has ever happened. We had highlighted before the meeting that the 4-2 vote could easily be derailed by just one member switching sides. As such, we had assigned a moderate probability to a cut of around 65%, but were still surprised when it happened.
The bulk of the statement was quite solidly neutral, but flecked with little pieces of hawkishness that coalesced into a quite definitely hawkish side of neutral conclusion and then Q&A afterwards in the press conference.
The growth narrative was broadly unchanged, with the SARB looking through the Q2 strength to see a much more mixed bag in Q3 and beyond. The inflation narrative saw a key move however with a marginal shift up in some of the numbers for the next two years (core notably) but also most important, a shift in the skew of risks from neutral to the upside – including from ZAR and related ratings risks which were surprisingly strongly put in the statement. Food was identified as a more definite downside risk, but overall adding in electricity prices, etc, the risk skew was seen to the upside. Other parts were more benign – the latest BER inflation expectations data showed long term stability in levels at 5.9% but a slightly drop in nearer years. The MPC still characterises this as uncomfortably close to the top end of the band and barely anchored.
Given the risk outlook, we do believe that keeping rates unchanged is the right move. As we previously stated at the last meeting, while there was short run market scope for a reduction in rates at the time – we thought with hindsight after the MTBPS and with index risks next year – it would have looked like a mistake. Indeed this meeting today for us highlights more the issue with the July cut. However, we think there is a credibility issue with doves pushing that this would be a (shallow) cycle with intermeeting speeches, and yet we may well have been “one and done”. In the end, there is a balance between credibility and consistency. Today’s decision was a disappointment vs expectations and understanding of the cohesiveness of the dovish camp, but does correct somewhat for a ‘mistake’ at the last meeting if we take a step back.
This factor is important, however, for what comes next. As we pointed out last month – we never did view this as a real cycle but a possible series of opportunistic cuts. Going forwards, we see November being too high a risk point for a cut and indeed there may well be a smaller number of members voting for a cut at that point than today. Equally however if there are any CPI surprises that shift the CPI forecast back lower – a vote to cut could suddenly be sustained in the face of risks or they think they have waited long enough since July. This is ultimately the problem looking at the rate outlook. We have a group of doves who are happy to discount some of the risk outlook and its impact on the currency and into inflation and are impatient waiting for risk events, and a group of hawks looking at things very differently where the ‘fear’ around inflation risk still prevent cuts given patience waiting for risk events to pass.
Next year is likely to operate still very much along this ‘fear vs impatience’ axis. Our baseline has been that rates will remain unchanged (now at 6.75%) through next year, given the risk profile outlook and we also see a somewhat higher base in inflation through end year and slightly stickier core (more in the outlook through end next year than through end this year relative to the SARB). However, in reality rates are unlikely to be totally flat and we actually see the outlook as very bimodal.
Rate hikes can occur if the consistent hawks and (at least) one swing member can be dominated by concerns around fiscal, ratings, politics and then index exit and its implications. We could see 50bp or so of hikes (or more if there is disorderly outflow but we do not see it as a major balance of payments event). A large Eskom tariff increase can also skew the risk towards hikes. The SARB pencils in 8% for tariff increases next year, but there is a 19.9% MYPD-III application and on top of that a significant RCA application which may well be another 30% recoverable over several years. We have pencilled in 12% for next year.
But cuts could also occur if there is a view of a rating reprieve and benign politics that in effects takes risks out of 2018. We originally saw a possibility of cuts to 6.00% (with a 25bp at this meeting) but would for now stick with a simple view of 50bp possible next year on such a benign outcome.
SARB policy will remain very much meeting by meeting. We think the market overestimates the downside skew in rates when there is the probability of hikes to come; consequently, pricing should be more cautious.