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Interest Rate Barometer

Executive Summary The interest rate barometer considers the factors influencing the decision

of the SARB’s Monetary Policy Committee’s last meeting on 20 July 2017 as

well as developments since the last meeting (which, in our view, could

influence the MPC rate decision on 21 September 2017). The factors are

rated on a stand-alone basis as a likely hike, hold or cut and are weighted

into three broad categories: global economy (20%), domestic economy

(40%) and major inflation drivers (40%) (see Table 1).

Of the 13 factors analysed, six support expectations for a cut and seven

factors support an unchanged stance. On a weighted basis, this implies a

57% probability of a hold at next week’s MPC meeting on 19 to 21

September 2017.

However, the July 2017 MPC meeting reflected a slight shift in focus of the

MPC towards growth since inflation has already fallen within the SARB’s

target band. If we skew the weights to reflect this increased focus on

growth, we get an almost even split between a hold and a cut decision.

Based on our analysis, we are of the opinion that the repo rate could be

reduced by 25bps next week. We are expecting the SARB to revise its

inflation profile slightly lower for 2017, while its growth forecasts are

expected to remain unchanged. We believe that the SARB is likely to

reiterate the vulnerability of the rand exchange rate due to event risks on

the horizon.

We believe that the rand and the local socio-political risk premium remain

key swing factors, given their fluidity. Key event-risks in the form of

geopolitical tensions, possible credit rating downgrades and local political

headlines, combined with a Fed rate hike profile will also have a bearing on

local monetary policy decisions, in our opinion.

Table 1:

Factors SARB outlook at the July policy meeting Recent developments Rate impact

GLOBAL

ECONOMY (20%)

Growth The global growth backdrop remains positive, with sustained upswings evident in most regions. This is despite continued uncertainty regarding economic policy reforms in the US. Nevertheless, growth rates and potential output estimates are still generally lower than those in the pre-crisis period. While there are lingering concerns about financial stability risks from the shadow banking sector in China, the recent strong performance of the economy has contributed to the favourable environment for emerging markets.

In its July 2017 World Economic Outlook Update, the IMF left its global growth forecast unchanged at 3.5% and 3.6% over the next two years, however, it cut the forecast for developed economies and raised the forecast for emerging markets. Risks to the growth forecast are broadly balanced, but remain on the downside over the medium-term. Some concerns are a less expansionary fiscal policy stance in the US, a possible market correction, monetary policy normalisation in the DMs, geopolitical risks and global tightening financial market conditions.

HOLD

Inflation and interest rates

Underlying global inflation trends remain benign, with inflation below target in most of the advanced economies, notwithstanding the positive growth prognosis and tightening labour markets. An exception is the UK where inflation has accelerated in the wake of the Brexit-induced depreciation of sterling. The subdued global inflation outlook is reinforced by generally slow wage and productivity growth in developed economies. Despite the absence of inflationary pressures, central banks in a number of advanced economies have signalled intentions to move from highly accommodative monetary policy stances. The gradual nature of the planned balance sheet contraction by the Fed has also been well communicated and appears to be largely priced in by the markets.

Inflation in developed markets have surprised recently, with sluggish inflation in the US and Eurozone and surging inflation in the UK. Nonetheless, the trajectory of inflation is still rising, with both the Fed and ECB expecting its 2% target to be reached over the medium-term. CPI within EMs is more nuanced, with easing pressures in some offset by rising pressures in others. Monetary policy is still divergent, with rising rates in the US and easy monetary policy in Europe and most of Asia. However, given the modest recovery seen in the Eurozone and sharply higher inflation rate in the UK, the market is pricing in tapering of QE in the Eurozone and higher interest rates in the UK next year.

HOLD

Oil price The persistent global oil supply glut, along with increased shale gas production in the US, has undermined efforts by OPEC and other producers to support prices through output restrictions. Since the beginning of June, Brent crude oil prices have traded at levels below US$50 per barrel, and the Bank’s oil price assumptions have been revised down over the forecast period. These recent oil price trends, along with the stronger exchange rate, contributed to a 69 cent per litre reduction in the petrol price in July. Following a weakening of the rand and a partial recovery in crude oil prices, a moderate petrol price increase is expected in August.

The oil price trended higher since the last MPC meeting with Brent trading between a $48/bbl. and $56/bbl. In or view, this is because of a few factors: Saudi Arabia indicate that it is considering extending production cuts further out into 2018, OPEC upwardly revised its global oil demand forecast recently, severe weather conditions in the US forced some oil refineries to temporarily shut down and US oil rig activity has slowed and inventories continue to fall. We still anticipate some downside risk to the oil price over the medium-term due to the glut situation as production from the US recovers.

HOLD

15 September 2017

Nedbank CIB Research

Reezwana Sumad

+27 11 294 1753

ReezwanaS@Nedbank.co.za

www.nedbank.co.za/researchportal

Interest rate barometer | 15 September 2017 Page 2 of 4

Table 1 (continued)

Factors SARB outlook at the July policy meeting Recent developments Rate impact

DOMESTIC ECONOMY

(40%)

SARB’s GDP forecast

While positive growth is expected in the second quarter, the Bank’s annual growth forecasts have been revised down further. The forecast for 2017 has been adjusted down from 1.0% to 0.5%, and the forecast for 2018 is down from 1.5% to 1.2%. Growth of 1.5% is expected in 2019, compared with 1.7% previously.

As a result of these trends, the output gap has widened somewhat despite a further downward revision to potential output growth by 0.3 percentage points for each year, to 1.1% in 2017 and rising to 1.3% in 2019.

While SA GDP growth rebounded to 2.5% qoq in 2Q17, this was off the low base in 1Q17. Confidence levels, however, remain very low and this could possibly keep economic growth subdued over the medium-term. Confidence indicators have recently become hypersensitive to political developments, which mean low confidence and low growth anticipated into year-end. The IMF, World Bank, SARB and Bloomberg consensus already revised the 2017 full-year growth forecast to between 0.5% and 0.8%. Even 2018 growth will likely remain below potential.

CUT

Domestic supply

Monthly data for both the mining and manufacturing sectors in April and May suggest that, in the absence of a sharp contraction in June, these sectors are likely to contribute positively to growth in the second quarter, along with the continued rebound in the agricultural sector. The recovery is nevertheless expected to be modest, particularly in the light of a sharp fall in the ABSA Purchasing Mangers’ Index in June, which returned to below the neutral level of 50 index points. The construction sector also remains under pressure following the marked fall in building plans passed in the first quarter of this year, with the negative trend continuing into April.

SA’s mining production growth came in at 0.9% yoy in July 2017, from 1.3% previously, but was worse than consensus of +2%. For the month, however, mining production contracted by 0.4% and signals a negative start to the third quarter – we believe that if this subdued pace of production is maintained, it may mean that the mining and quarrying contribution to GDP growth will be minimal or even negative. Manufacturing production contracted by 1.4% yoy in July 2017, from -2.2% in June 2017 (worse than consensus of -0.3%). The PMI indicator remains below the 50-point level and indicates that manufacturing output will probably remain subdued over the medium-term, unless global demand picks up materially.

CUT

Domestic demand

Consumption expenditure by households contracted in the first quarter of this year, amid a further deterioration in consumer confidence. Although the monthly retail sales data suggest a more positive outcome for the second quarter, this improvement is likely to be offset in part by a decrease in new vehicle sales in the quarter. The outlook for consumption expenditure is expected to remain weak, amid employment uncertainty and higher tax burdens.

Total new vehicle sales rose by 6.7% to 49,222 units, boosted by a jump in commercial vehicles. Export volumes dipped following a strong increase in July 2017. Vehicle sales are likely to pick up in the months ahead off a low base, with the interest rate cut adding some boost, but the trend will possibly be subdued as the adverse political and subdued economic climates dampen the recovery.

SA retail sales growth eased to 1.8% yoy in July 2017, from 3.2% in June 2017 (worse than consensus of 2.5%). Over the month, sales contracted 0.6%, from 0.6% growth in June 2017.

HOLD

Monetary conditions

These consumption trends are mirrored in the continued moderation in credit extension to households. Growth in mortgage advances and instalment sales credit finance remained subdued, reflective of the difficult conditions in the housing and vehicle markets. General loans to households increased moderately in May, but off a low base. Credit extension to the corporate sector, by contrast, remains relatively buoyant, but on a downward trend.

Private sector credit extension (PSCE) growth was unchanged at 5.7% yoy, lower than the market’s forecast of 6.1% from 6.2% in June 2017, with growth in credit to households picking up, while that to companies eased.

General credit conditions will remain subdued given weak household and business confidence and weak demand, in our opinion.

CUT

Forecast of inflation

The Bank’s forecast for headline CPI inflation has shown a marked improvement since the previous meeting. The annual average forecast has been revised down by 0.4 percentage points in 2017 and 2018, and by 0.3 percentage points in 2019, to 5.3%, 4.9% and 5.2%. A lower turning point of 4.6% is expected in the first quarter of 2018 (previously 5.1%), and an average of 5.2% is forecast for the final quarter of 2019.

The main drivers of the improved forecast were the lower starting point; revised assumptions regarding international oil prices, domestic electricity tariffs and the real effective exchange rate; and a wider output gap.

CPI has fallen below consensus in five out of the last seven months. In the latest print, CPI fell to 4.6% yoy in July 2017. This means that CPI is now within a whisker of the mid-point of the SARBs target band. CPI has fallen below the SARB’s forecast in the last two quarters and is expected to fall below the SARB’s forecast in the remaining two quarters of the year. Nedbank currently forecasts an average CPI rate of 5.2% in 2017 and 5.1% in 2018. Currently, 64% of the CPI basket’s subcomponents falls below the 6% target, with this proportion expected to rise in coming months.

CUT

Market expectations

The FRA curve is highly compressed, and driven by a surge in foreign investor interest in recent months. The FRA curve has remained inverted since the March meeting. The FRA market is currently pricing in a 61% probability of a rate cut in 5 months’ time, and a 29% probability of a cut by August.

The FRA market has been driven by investor complacency in recent months. The FRAs have capitulated to price in interest rate cuts since March 2017. The FRA market is currently pricing in an 81% probability of a rate cut at the SARB’s meeting next week and a 133% probability of a cut by November 2017.

CUT

INFLATION DRIVERS

(40%)

Food prices Food price inflation is also expected to be more subdued, due to a lower starting point and more favourable domestic crop estimates. Despite a persistent upward trend in meat price inflation, the forecast for food price inflation has been revised down from 7.7% to 7.3% for this year; and from 5.4% to 5.1% in 2018. The forecast for 2019 is unchanged at 5.5%.

Food inflation eased to 6.8% yoy in March 2017, due to lower maize and grain prices. Meat inflation will likely remain elevated through 2017 as farmers have started restocking their herds. However, this is expected to be more than offset by lower grain prices. The SA white maize price has, however, risen by 1% since the last MPC meeting, but is still 53% lower on an annualised basis. Hence this may ease food inflation further in coming months. Fruit and veg prices are currently in deflation due to the better harvests and weather conditions.

HOLD

Rand exchange rate

While the rand is more or less unchanged since the previous meeting of the MPC, it has been relatively volatile, having fluctuated in a range between R12.60 and R13.60 against the US dollar.

The rand’s relative resilience had been underpinned by the generally positive sentiment towards emerging markets, as well as by sustained trade surpluses. The current account deficit is still expected to widen over the forecast period, but the degree of widening has been revised down. The rand remains vulnerable to increased global risk aversion, domestic political shocks, and to the possibility of further ratings downgrades.

Since the last MPC meeting, the rand weakened by 1.4% against the dollar, maintaining a range of between R12.77-13.47/$. The USDZAR is 7.4% stronger on an annualised basis, while the trade-weighted rand is 6.4% stronger (albeit off a very weak base). The outlook for the rand remains highly uncertain, in our view. Given the strong probability of further credit rating downgrades and heightened political risks, the rand may remain volatile. Should these risks not materialise, it may keep the rand on the current strengthening (consolidation) trend over the medium-term.

HOLD

Administered prices

These recent oil price trends, along with the stronger exchange rate, contributed to a 69 cent per litre reduction in the petrol price in July. Following a weakening of the rand and a partial recovery in crude oil prices, a moderate petrol price increase is expected in August. A further upside risk relates to the possible supply side shock of a large electricity tariff increase from July next year. Eskom has approached Nersa for an increase of around 20%, but the current forecast assumes an increase of 8%. This assumption will be adjusted in line with any new determinations made by Nersa.

Since the March 2017 policy meeting, the local petrol price rose by 86c/litre (6.7%). The current under recovery in the petrol price stands at 36c/litre, implying a further petrol price hike in the coming month, in our view. However, transport inflation is just 1% yoy as at July 2017 and administered price inflation slumped to 1.8% yoy in July 2017, from 4.9% previously. We believe that the lower than expected increase granted to Eskom by NERSA for the current year (2.5% vs >8% requested) softens the inflation profile marginally. However, a key risk to administered prices over the next 18 months comes from utilities costs as Eskom may apply for at least a 17% tariff hike from Nersa, in our view.

CUT

Wage settlements

Wage trends have been an important contributor to the persistence of inflation at higher levels. There are, however, indications of some moderation in average salaries, and related unit labour costs, which are expected to remain below the 6% level over the forecast period. The outcome of a number of multi-year wage agreements that are due for renewal in 2017 will be closely watched as they could pose a risk to the inflation trajectory. Inflation expectations as reflected in the survey conducted by the Bureau for Economic Research show a marginal improvement, with average expectations slightly below 6% in all three years.

Inflation expectations currently average 5.9%. Real wage growth per worker accelerated from -0.5% in the fourth quarter of 2016, to 1.0% in the first quarter of 2017, as nominal wage growth accelerated while consumer price inflation slowed somewhat. Public sector remuneration growth per worker accelerated from 8.5% in the fourth quarter of 2016 to 10.7% in the first quarter of 2017. Remuneration growth per worker in the private sector accelerated somewhat from 4.4% in the fourth quarter of 2016 to 5.2% in the first quarter of 2017. Real wage growth is expected to average around 1.4% over the medium-term, with downside risks. The implementation of the National Minimum Wage should pose some upside pressure on wage settlements when it does materialise.

HOLD

Source: SARB, Nedbank

Interest rate barometer | 15 September 2017 Page 3 of 4

Table 2: Probability of outcomes

Impact Unweighted Probabilities Weighted probabilities

Global economy (20%) Cut 0% 0%

Hold 100% 20%

Hike 0% 0%

Domestic (40%) Cut 83% 33%

Hold 17% 7%

Hike 0% 0%

Inflation drivers (40%) Cut 25% 10%

Hold 75% 30%

Hike 0% 0%

Final Result Cut 46% 43%

Hold 54% 57%

Hike 0% 0%

Source: Nedbank

FRA Market certain of rate cut by year-end

Administered price inflation is well below 3%

Higher international oil price pushes up local petrol price

Most of the CPI basket lies below the 6% upper target

Lower food inflation expected to ease headline CPI

Trade-weighted rand loses ground since March 2017

Source: Bloomberg, Stats SA, Nedbank

Interest rate barometer | 15 September 2017 Page 4 of 4

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