SARB acknowledges cyclical disinflation with rate cut
Implications for fixed income and equity portfolios.
As had been widely anticipated by the market, the South African Reserve Bank (SARB) cut interest rates by 25 basis points today. This in line with our long-held view that the South Africa economy is experiencing sustained disinflation, driven by the lack of demand in the economy and the SARB’s determination to get inflation to the middle of the target band at 4.5%.
Indeed, the cyclical elements of inflation – traditionally a function of supply and demand – are running very low at closer to 2-3%. The only drivers of inflation in the economy are administered prices (such as electricity tariffs and tax hikes), combined with periods of higher oil prices and episodes of rand depreciation.
The SARB has long maintained that the impediments to growth are structural rather than cyclical, and that South Africa needs reforms rather than rate cuts. While this view holds true, it appears that they are finally acknowledging that there may be a cyclical element to the growth slowdown too and have accordingly responded by easing policy.
However, the SARB has to maintain a careful balance in the months ahead and have dealt with this by accompanying today’s cut with a cautious statement. While there is a strong argument from a cyclical perspective to cut further, South Africa’s litany of structural problems means that the extent to which they can ease has a floor – in our view at between 50 and 75 basis points overall. More than that would require a meaningful improvement in the structural impediments to growth. For now, we are simply too dependent on foreign capital to fund our fiscal and current account deficits.
Portfolio positioning | Investec Diversified Income
Domestic bonds have had an exceptional – if bumpy – year, with the All Bond Index returning almost 11.5% to the end of June. We have participated in this upside and continue to have a constructive view on domestic bonds, as we believe they are a better expression of this disinflation theme than listed property. With our portfolio yielding close to 8.75% and inflation running at 4.5%, fixed income provides a meaningful real return. In addition, we believe there is further capital uplift to come from bonds.
We are underweight our offshore allocation, as we expect the US Federal Reserve to ease and central banks globally to remain supportive. However, our offshore allocation provides some protection against the multitude of risks locally and globally.