After a prolonged period of relative calmness, the first quarter of 2018 has been characterised by the return of volatility in both international and in local markets. Starting with the broader picture, global markets started the year enthused by continued broad-based economic strength, while an upbeat US employment data release in January proved an unexpected catalyst triggering a spike in risk aversion.
Sustained US labour market strength has focused investors’ attention on the reality of “quantitative tightening”, with growing concern that inflationary pressures could force central banks to pursue more aggressive policy normalisation than expected. Volatility persisted during the quarter amid escalating tensions between the US and China regarding import tariffs, which threatened to constrain trade and in turn harm global growth.
At the same time, the domestic market continued to celebrate the election of Cyril Ramaphosa as the African National Congress’s (ANC) new leader late last year, which culminated in him being voted President by the National Assembly after Jacob Zuma’s reluctant resignation mid-February.
When the International Monetary Fund (IMF) upgraded its forecast for global growth in January, it simultaneously and surprisingly revised downwards its South African (SA) growth forecasts to 0.9% for both 2018 and 2019. The institution was primarily concerned about uncertainty around political developments and our institutional framework at the time. Post quarter-end however, it upgraded its growth forecasts to 1.5% and 1.7% for the next 2 years, reflecting the positive developments that the country has undergone so far this year.
It was also pleasing to see that 2017 GDP growth (+1.3%) beat estimates, more than doubling the rate of growth seen in 2016. GDP has now grown at above 2% (quarter on quarter) for 3 consecutive quarters, which has not occurred since 2011.
The pickup in growth was largely due to a strong rebound in agriculture and mining from very depressed levels. The higher base means that these sectors are unlikely to have an outsized repeat contribution this year, so growth will need to come from other sources. The South African Reserve Bank expects growth of 1.5% this year, rising to 2% in 2020, but given the revival of consumer and business confidence, and improved household consumption and real incomes, these could prove conservative. While 1.5% to 2% growth is not particularly impressive in the context of emerging market growth, and weaker than our democratic era average of 3%, we are encouraged by the direction in which we are heading.
When the South African Reserve Bank’s Monetary Policy Committee (MPC) met in January, domestic risks overshadowed the deceleration in inflation over previous months. The awaited February National Budget Speech and the imminent potential downgrade by the last remaining key credit rating agency, Moody’s Investor Services, prompted the MPC to keep rates on hold.
By the March MPC meeting, a favourable and market-friendly Budget had been laid out, appeasing Moody’s which then maintained our investment grade rating, while also upgrading the outlook to “stable”. Following this, the MPC elected to lower the repo rate by 0.25%; the second interest rate reduction in the current cutting cycle.
At this stage the market appears to be pricing in a further interest cut at some point this year, with the SARB’s Quarterly Projection Model guiding to higher rates further out. Our view is that the current cutting cycle should be shallow, and remains in contrast to the policy tightening seen in the US.
The SARB is making a concerted effort to anchor inflation expectations at the mid-point (4.5%) of the inflation target range of 3%-6%. Historically, the upper end of the band has shown some structural inertia. This mind shift comes at an opportune time, given the deceleration in inflation in recent months, driven by lower food inflation and a stronger rand.
These positive shocks that have driven inflation to below 4.5% have since dissipated somewhat (lower electricity and food prices and rand strength), and inflation is set to rise modestly towards 5% in the medium term. The recent VAT increase is a further contributor to higher prices, but the base effect should only present a temporary increase in inflation.
Lastly, this positive momentum in developments locally on the political and economic front is encouraging. SA has the opportunity to participate more meaningfully in the favourable global backdrop, albeit at a late stage. Though recent higher frequency data suggest the initial euphoria could taper slightly, the trend towards improvement is reassuring.
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