The policy rate remained unchanged as expected.
The SARB delivered a dovish, but highly cautious, monetary policy assessment.
Heightened uncertainty around the exchange rate's path, given global anddomestic political risks and the possible impact of further downgrades remain aconcern for the Bank. While inflation risks have returned to more or less balanced,the currency's vulnerability to changes in sentiment still remains an upside riskto inflation. Inflation and growth forecasts were revised downward as expected,possibly supporting the one member still arguing for a rate cut. Broad-baseddownside surprises in core inflation, a resilient rand exchange rate, and downsiderisks to growth are more likely to lead to future rate cuts, than hikes, as some inthe market still believe.
Bottom line: Inflation trends are largely moving as we expected, but the SARBwill need more evidence of the medium-term profile improving. For this tohappen, we think weakness in wage and employment growth will be the mostconvincing. But further positive inflation surprises will also help. We still seemore than an even chance that the SARB cuts rates in Q3 - possibly September(25bps) and again in November (25bps). Market conditions will play a criticalrole in the timing in our view, given the main concern centers on how theexchange rate reacts to exogenous events going forward. That said, it wouldnow appear that the SARB has indeed built in scope for a short-term inflationsurprise, despite pointing to the contrary in the Q&A session.
Inflation forecast revisions were conservative in our view (see comparativecharts)The Bank cut headline CPI forecasts by a mere 0.2ppts and 0.1 ppts to 5.7%and 5.3% for 2017 and 2018 respectively, leaving the 5.5% for 2019 unchanged.
Core inflation was trimmed in light of the March surprise fall. Yesterday's data(headline and core at 5.3% and 4.8%) have not yet been incorporated, suggestingthere is more downside to core inflation forecasts of 5% (2017), 5.1% (2018)and possibly also 2019's 5.3% - revised down by 0.4ppts, 0.1ppts, unchanged.
Lower oil price and electricity tariffs were the main reason for these adjustments,which were in part countered by a less appreciated exchange rate forecast andreduced disinflation in food prices.
...especially what looks to be a much weaker exchange rate assumptionWe estimate that the SARB may have revised it's currency assumption for 2017up to R14.2/$ from R13.4/$ (DB estimates) in March. However, the Governorreported in the Q&A session that the likely impact of a downgrade, particularly oflocal currency ratings, has not been incorporated into its forecast. Importantly, forthis average exchange rate to be achieved this year, from R13.25/$ ytd, the randshould depreciate well above R15/$, or even R16/$ if its a short-term shock. Itwould thus appear to us that the Bank may have built-in considerable fat to allow for a combination of risk events. As the implied fx forecast for 2018 reverts backto an average R14.3/$, the Bank has made allowance for a short term fx shock.
… and wage growth still contributing to a high degree of persistencyThe Bank remains concerned over the general persistency of inflation, in partdriven by high unit labour costs (ULC). It notes that wage increases havemoderated, but are still consistent with high inflation persistence. Owing tothe weaker economic growth projections, the Bank has however, revised ULCslightly upwards. This continues to explain the stickiness in their medium-termforecasts relative to our view. While we concur that weaker growth may addpressure to ULC, we believe that economic and political uncertainty will insteadpressure wage growth even lower (DBe 6.5-7% vs SARBe 8%), while possiblyalso triggering further, but moderate job cuts. This should compensate forweakness in growth, still allowing ULC to deflate towards 5% if not lower (vsSARBe c. 5.7-6%).
Growth forecasts assuming a lower path with lingering demand weaknessDownward revisions of 0.2% to 0.3% in light of the recent credit downgradeswere largely as expected. However, the Bank's 1% expectation (vs DBe 0.6%) forthis year seems to be on the high side. We think growth in Q1 would have beenweak at no more than 0.6% qoq saar (up from -0.3%). Further downside in Q2may be likely judging from recent trends, in our view.
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