SARB likely to cut interest rates in coming months

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Cape Town – The expectation of the South African Reserve Bank (SARB) cutting interest rates in the coming months seems more likely after its recent decision to leave its benchmark repo rate unchanged at 6.75%.

This according to Overberg Asset Management (OAM) in its weekly overview of the economic landscape. 

In its report, OAM pointed to a strengthening rand, a lowered CPI forecast and SARB’s decision to leave the repo rate unchanged as possible indicators of an impending rate cut.

South Africa economic review

• Retail sales surged in November by 4.0% month-on-month. On a year-on-year basis retail sales jumped 8.2% up from 3.5% in October and well above the 3.5% consensus forecast. The sharp increase is attributed to consumers taking advantage of “Black Friday” retail discounts.

Among the retail categories posting the strongest growth “other retailers”, “household furniture and appliance” and “textile and clothing” grew sales by 20.8%, 14.1% and 12.4%, respectively. In the year to end November retail sales increased 2.7% up from 1.9% growth in the same period in 2016.

Retail sales comprise around 6.2% of GDP. The outlook for retail sales in 2018 is brightened by prospects for a stronger rand, lower inflation and declining interest rates, providing relief to consumers. Reduced political and policy uncertainty should boost consumer confidence and household credit extension.

• As expected the South African Reserve Bank (SARB) kept its benchmark repo rate unchanged at 6.75% although the decision was not unanimous with one of the six Monetary Policy Committee (MPC) members voting for an interest rate cut. The SARB raised its GDP forecasts for 2017, 2018 and 2019 from a previous 0.7%, 1.2% and 1.5% to 0.9%, 1.4% and 1.6%, respectively.

At the same time, the SARB also reduced its forecasts for consumer price inflation (CPI) for 2018 and 2019 from 5.2% and 5.5% to 4.9% and 5.4%. Its forecasts for core CPI, excluding food and energy prices, reduced from 5.1% to 4.6% for 2018 and from 5.3% to 5.1% for 2019.

Despite the improving macroeconomic environment, the MPC raised concerns over February’s Budget and Moody’s potential credit downgrade to junk status at its rating review in March. However, if the rand maintains its recent strength beyond these two watershed events, there is a strong likelihood the SARB will cut the repo rate in subsequent meetings. (See Bottom Line for further analysis).

• Mining production growth accelerated on a year-on-year basis to 6.5% in November up from 5.2% in October. The biggest contributors were platinum group metals and iron ore, which grew 12.3% and 20.7% on the year contributing 2.8 and 2.5 percentage points to headline growth, respectively.

Mining production was less impressive over the short-term, dropping in November by 0.7% month-on-month and in the three months to end November by 1.1% quarter-on-quarter. Despite a mixed performance in November the outlook for mining in 2018 remains positive, buoyed by strong global economic growth, rising international commodity prices and prospects for greater certainty in South African mining legislation.

• Foreign investors bought a net R5.936bn of South African equities in the week to 19th January while total net bond inflows measured R0.569bn.

In the year-to-date net equity and bond inflows total R5.424bn and -R0.025bn, respectively. The year has got off to a good start. Continued foreign equity investor inflows over coming months depend on further progress in government policy, improvement in business and consumer confidence, and a stable rand.

The week ahead

• Composite leading business cycle indicator: Due on Tuesday, January 23. Having jumped sharply higher in October to its highest level since 2013 the leading business cycle indicator is expected to consolidate recent gains in the November reading. The South African Reserve Bank leading indicator indicates expected business conditions 6-12 months ahead.

• Consumer price inflation (CPI): Due on Wednesday, January 24. According to consensus forecast CPI is expected to lift slightly to 4.7% year-on-year in December from 4.6% in November.

The expected lift is attributed to the increase in petrol and diesel prices during the month of 71 cents and 60 cents per litre. In 2017 CPI averaged 5.3% down from 6.3% in 2016. The South African Reserve Bank forecasts headline CPI will reduce further to 4.8% in 2018 well within its 3-6% target range.

• Producer price inflation (PPI): Due on Thursday, January 25. The December increase in petrol and diesel prices is expected to contribute to a slight pick-up in PPI in December to 5.2% year-on-year from 5.1% in November, according to consensus forecast.

• Conclusion of World Economic Forum meeting Davos: Due on Friday, January 26. The South African delegation to the World Economic Forum, led by ANC president Cyril Ramaphosa, is expected to make a positive impression on the global investment and business community.

Technical analysis

• Having broken key resistance levels at R/$13.50 and R/$12.50, the rand has returned to its appreciating trend, targeting a break below R/$11.70 over coming months.

• The US dollar index has tried but failed to break through a major 30-year resistance line suggesting the three-year bull run in the dollar may be over.

• The British pound has broken above key resistance at £/$1.35, promoting further near-term currency gains to a target range of £/$1.40-1.50.

• The JPMorgan global bond index is testing the support line from the bull market stemming back to 1989, which if broken will project further sharp increases in bond yields.

• The US 10-year Treasury yield has failed to break below key resistance at 2.0% raising the probability that the multi-year bull trend in US bonds is over.

• The benchmark R186 2025 SA Gilt yield has broken below key resistance at 9.0% indicating the potential for a new target trading range of 8.0-8.5%.

• Key US equity indices, including the S&P 500, Dow Jones Industrial, Dow Jones Transport, Nasdaq and Russell 2000, have simultaneously set new record highs, confirming a bullish outlook for US equity markets.  

• The Brent oil price has broken above key resistance at $60 and is likely to remain in a trading range of $60-70 over the foreseeable future. Base metal prices are in a bull trend confirmed by copper’s increase above key resistance at $7 000 per ton.

• Gold has developed an inverse “head and shoulders” pattern, which indicates further upward momentum and a test of the $1 400 target level.

• The break in the JSE All Share index above key resistance levels at 56 000 and 60 000 signal the early stages of a new bull market.

Bottom line

• While the South African Reserve Bank (SARB) left its benchmark repo rate unchanged at 6.75% there was a clear shift in tone. The Monetary Policy Committee (MPC) statement was decidedly “dovish”, raising the likelihood of interest rate cuts over coming months.

• The outlook for a cut in interest rates has improved markedly. Following the SARB’s January policy meeting the Forward Rate Agreement market has re-priced the probability of a 25 basis-point rate cut in March to 80%. There is a 100% probability of a rate cut by June 2018.

• The SARB has dramatically lowered its forecast for core consumer price inflation (CPI) for 2018 from a previous 5.1% to 4.6%. Core CPI excludes food and energy prices, which tend to be volatile over the short-term and not indicative of consumer demand levels.

• A strengthening rand will allow the SARB to cut its inflation forecast even further, paving the way for interest rate cuts. On a trade weighted basis, the rand has strengthened by 10.6% since the SARB’s last monetary policy meeting in November. The rand has been boosted by the market-favourable outcome of the ANC elective conference, a strengthening in global economic growth and rising international commodity prices.

• The SARB cited two key risks to the rand, most notably the February Budget and the March credit rating review by Moody’s. Fortunately, early signals indicate a positive outcome for each of these two concerns.

• The appointment of a new board for Eskom indicates an abrupt change in government policy direction and an urgency in addressing the financial health of State-Owned Enterprises (SOEs). The financial health of SOEs is a key determinant of the country’s fiscal stability. The broad macroeconomic policies proposed by Ramaphosa ahead of the ANC elections, include fiscal discipline, debt discipline and reformed governance at SOEs.

• In a post ANC election report issued last week, Moody’s credit rating agency said that the election of Ramaphosa opens up the tentative possibility of a “credit positive” shift in South African policy. Moody’s is the sole credit rating agency still awarding South Africa an investment grade rating on its local currency debt making the continuation of this rating crucial to keeping South African local debt included in key global bond indices.

• The positive outlook for the rand, inflation and interest rates significantly brightens the prospects for consumer and business confidence and the prospects for the JSE. Premised largely on the expectations for a strengthening rand and declining interest rates, Goldman Sachs has identified South Africa as the “big emerging market story” of 2018.

For the full report, including a look at international markets, click here.

* Overberg Asset Management (OAM) is an Authorised Financial Services Provider No. 783. Overberg specialises in the private management of local and global discretionary portfolios as well as pension products.

Disclaimer:

Information and opinions presented in this report were obtained or derived from public sources that Overberg Asset Management believes are reliable but makes no representations as to their accuracy or completeness. Any opinions, forecasts or estimates herein constitute a judgement as at the date of this Report and should not be relied upon. There can be no assurance that future results or events will be consistent with any such opinions, forecasts or estimates. Furthermore, Overberg Asset Management accepts no responsibility or liability for any loss arising from the use of or reliance placed upon the material presented in this report.

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