South Africa Maintains Rate at 7% Despite Inflation Risk in May

Johannesburg, South Africa, Capital Markets in Africa: The pause in the South African central bank’s policy tightening cycle may be short-lived as it forecast increasing risks for inflation from a weaker rand and food prices.

The repurchase rate was left unchanged at 7 percent, Governor Lesetja Kganyago told reporters on Thursday in the capital, Pretoria. Nineteen of the 25 economists in a Bloomberg survey predicted no change to borrowing costs. Five of the six members Monetary Policy Committee members preferred to keep the rate unchanged and one favored a quarter percentage point increase, Kganyago said.

The MPC has raised interest rates by 125 basis-points since July to control inflation even as the economic outlook worsened and the nation’s debt risks being downgraded to junk. The bank’s task has been made more difficult by weakening investor confidence since December, when President Jacob Zumaun expectedly fired his finance minister, followed by a power struggle between the president and current Finance Minister Pravin Gordhan over control of the National Treasury.

“The Reserve Bank feels the interest-rate increases they have put through are having some effect and that they don’t want to be too aggressive in tightening,” Kevin Lings, an economist at Stanlib Asset Management, said by phone from Johannesburg. “I still think we will see further rate hikes later this year. I think that will come about as inflation goes above 7 percent. ”

The weak rand and the worst drought in more than a century have boosted food costs and threaten to keep inflation outside the central bank’s 3 percent to 6 percent target range for an extended period. While consumer-price growth slowed to 6.2 percent in April, it will probably peak at 7.3 percent in three months through September and exceed the central bank’s target until the third quarter of 2017 Kganyago said. There are indications that the pass-through from the exchange rate to inflation is increasing and food-price growth is forecast to climb to about 12 percent in the third quarter of this year, he said.

“Although headline CPI inflation has moderated since February, the respite is expected to be temporary, as food and petrol price pressures continue to intensify,” Kganyago said. The MPC “remains concerned that inflation expectations remain at uncomfortably high levels.”

The drought and low commodity prices are hurting economic growth and the MPC cut its 2016 growth forecast to 0.6 percent from 0.8 percent. Sluggish growth is a key risk to the nation’s credit rating, with S&P Global Ratings and Fitch Ratings Ltd. reviewing their assessments, currently at the lowest investment-grade level, in the next two weeks.

Political tensions increased this week, pushing the rand to a two-month low, as Gordhan issued a statement accusing government officials of conspiring to intimidate him and his family and described allegations that he had spied on taxpayers when he ran the national revenue service as “malicious rumors” that were “manufactured for other motives.” This followed a Sunday Times report, which cited unidentified people, that he’s at risk of being charged with espionage and fired.

South Africa’s credit rating and political risks will be the key drivers for further interest-rates increases, Razia Khan, head of Africa research at Standard Chartered Plc in London, said in an e-mailed note to clients.

“Should we see a sizable, adverse rand reaction to any rating downgrade, or deterioration in the political backdrop, then the prospect of further tightening is likely to increase,” Khan said. “The SARB sees the current monetary policy stance as ‘accommodative’, implying there is still room for further tightening.”

The rand fell to as low as 15.9823 after the decision and was 0.1 percent weaker at 15.8927 per dollar as of 5:59 p.m. in Johannesburg on Thursday. Yields on on rand-denominated government bonds due December 2026 fell two basis points to 9.46 percent.

The currency’s gains since March “were reversed as global growth concerns resurfaced in early May, and other domestic factors, including the low growth outlook, concerns about a possible ratings downgrade and more recently heightened political uncertainty impacted adversely on the currency,” Kganyago said. “The exchange rate remains highly sensitive to domestic political developments and risks of an earlier-than-expected tightening in U.S. monetary policy.”

It is clear that the MPC is worried about the effect of political uncertainty on the rand, Isaac Matshego, an economist at Nedbank Ltd., said by phone.

“We still expect further hikes, probably at the July and September” meetings, Matshego said. “Food prices and the movement of the rand are going to be key divers.”