Politics could derail SA’s first interest rate cut since 2012

President Jacob Zuma in the National Assembly on Thursday night. (Screen grab from SABC)
President Jacob Zuma in the National Assembly on Thursday night. (Screen grab from SABC)

Johannesburg - A stronger rand and falling inflation expectations may allow South African Reserve Bank governor Lesetja Kganyago to start cutting interest rates this year as long as political developments don’t derail the currency’s gains.

Higher commodity prices and the end of a severe drought have improved prospects for an economy that probably expanded at the slowest pace in seven years in 2016. This has boosted the rand and led to an expectation of lower inflation, even as political risks, such as the possibility that Finance Minister Pravin Gordhan may be replaced, still remain.

Forward-rate agreements starting in nine months, used to speculate on borrowing costs, show traders have started pricing in cuts in the repurchase rate. Breakeven rates, a measure of inflation expectations, have fallen 18 basis points in 2017 and were below the top end of the central bank’s 3% to 6% target band at least three times this year. The Reserve Bank has said it may be close to the end of the tightening cycle that saw the benchmark rate raised 200 basis points to 7% in the two years through March 2016.

“Our inflation profile has improved to such an extent that now not only can we think of no rates movement for the rest of this year, but some people are thinking about a rate cut,” George Herman, head of South African portfolios at Citadel Investment Services in Cape Town, said by phone. “They are actually in a very good place.”

The repurchase rate was last cut in July 2012, when then-Governor Gill Marcus dropped it by 50 basis points to 5%, the lowest in at least 14 years. The bar for lowering interest rates is very high, Kganyago said in November. The central bank “would like to see inflation expectations moderate so that they are more comfortably within the inflation-target range,” he said.

Political stability

Political turmoil, including now-dropped fraud charges against Gordhan, made the rand the most-volatile currency among those of major and emerging markets monitored by Bloomberg in 2016. He and President Jacob Zuma have been at loggerheads since the minister was reappointed to the Treasury in December 2015, disagreeing about the management of state-owned companies and the national tax agency. Zuma also rebuffed Gordhan’s request to fire Tom Moyane, the commissioner of the revenue service, for insubordination. In his February 22 budget, the finance chief allocated no new money for nuclear plants favoured by the president.

In November, prosecutors abandoned plans to charge Gordhan with fraud for approving the early retirement of a tax-agency official and then allowing him to be rehired on a contract basis. Gordhan said all the allegations against him are baseless and being driven by people intent on raiding the National Treasury.

Politics will pay a prominent role this year in the run-up to a conference in December when the ruling African National Congress elects a new leader.

Politics must remain “as stable as possible,” Thabi Leoka, an economist at Argon Asset Management in Johannesburg, said by phone. “Last year, a lot of rand weakness was due to political noise.”

The rand has gained 5.2% to the dollar in 2017, the best start to a year since 2012. A multiyear drought has subsided and inflation eased to 6.6% in January, the first slowdown in five months.

A government report on Tuesday will probably show South Africa’s economy didn’t expand at all on an annualised basis in the three months through December from the previous quarter, according to the median of 15 economists’ estimates compiled by Bloomberg.

“I’m sure the Reserve Bank would like to cut rates because it’s good for the economy,” Christie Viljoen, an economist at KPMG in Cape Town, said by phone. “Their primary mandate is inflation and they need to see that sustainably in the target before they can cut.”

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