Strategic Research| South Africa

G LOBAL M ARKETS

18 May 2015

Interest Rate Barometer

Executive Summary

Nedbank Capital Strategic Research

Mohammed Yaseen Nalla, CFA
+27 11 295 5430

MohammedN@Nedbankcapital.co.za

Reezwana Sumad
+27 11 294 1753
ReezwanaS@Nedbank.co.za

https://www.nedbankcapitalresearch.co.za

The interest rate barometer considers the factors influencing the decision
of the SARBs Monetary Policy Committee in the statement accompanying
the previous meetings interest rate decision (26/03/2015) as well as
developments since the previous meeting which could influence Thursdays
MPC rate decision. The factors are rated as a likely hike, hold or cut and are
weighted into 3 broad categories: global economy (20%), domestic
economy (40%) and major inflation drivers (40%) as per Table 1.
Of the 13 factors analysed above, 8 support expectations for an unchanged
policy, while 5 factors favour a hike and no factors favour a cut (see Table
2). Using the weightings, there is a 57% bias for rates to be unchanged, a
43% bias for a hike, and a 0% bias for rates to be cut. This has shifted
marginally more hawkish since the last MPC.
Our view is for rates to remain on hold for an unchanged repo rate at this
meeting. Low base effects and other domestic inflationary pressures have
remains in play since our last Barometer and MPC. As such, the probability
of a hike later in 2015 remains.
Disinflationary pressures in the developed world have abated somewhat
and inflation expectations have ticked higher. Oil prices have gained and
will result in a large base effect late in the year and early in 2016.

Our expectation for the global interest rate trajectory to remain flatter for
longer remains in play. We have long said that the debate around the
timing of the Fed hike is less important than the profile of such a hiking
cycle. We remain of the opinion that the Fed will hike in September.

Table 1

GLOBAL

Factors

Outlook at the March policy meeting

Recent developments

Rate
impact

Growth

The global economic outlook remains uncertain, with a

moderate slowdown in the US and China, and an
improvement in the outlook and performance of the euro
area and Japan. By contrast, the weaker euro and
accommodative ECB monetary policy have contributed to
improved growth prospects in the region. The Japanese
economy emerged from two quarters of negative growth,
while the larger emerging markets continued to be a drag
on global growth. Consensus forecasts are for both Russia
and Brazil to record negative growth rates in 2015. The
outlook for the Indian economy, by contrast, is more
positive.

The IMF left its global growth forecast for 2015 unchanged at
3.5%, while the 2016 forecast was upgraded to 3.8%, from
3.7% previously. The growth forecast for EMs and DMs
remained unchanged on the whole, however the US GDP
forecast was downwardly revised to 3.1% for both 2015 and
2016 (from 3.6% and 3.3% respectively, previously). Within
the EM space, the sharpest declines were seen in Russian and
Brazilian GDP forecasts Russia is expected to remain in a
recession for the next two years, while Brazils recession is
expected to end by 2016. Growth for SSA was downwardly
revised, along with SA growth, which is now forecasted at 2%
and 2.1% for 2015 and 2016 respectively.

HOLD

Inflation and
interest rates

Global financial markets continue to be dominated by

changing expectations of the timing and speed of
normalisation of US monetary policy. Uncertainty persists
regarding the timing of the first interest rate increase.
While the US prepares to tighten monetary policy, the
global trend has generally been towards policy easing or
maintaining an accommodative bias. Both Japan and the
euro area have continued with their quantitative easing
while a number of countries have eased their policy
further, amid benign inflation pressures and concerns
about deflation in some countries.

Since the March MPC, the US headline CPI has dipped into
deflation, while the targeted PCE measure remains marginally
above zero. UK CPI is at 0%, along with the Eurozone, which
has managed to move away from deflation due to massive QE
extended. The BOE and Fed are expecting inflation to reach
the targeted 2% level within 2 years, while the ECB is seeing
inflation expectations reach that level in the same time
period. Disinflation is also being seen in some EMs, with policy
now tilted to easy monetary policy globally. Financial market
volatility is being fed by the uncertainty regarding the timing
of a Fed interest rate hike.

HOLD

ECONOMY
(20%)

Important disclosures can be found in the disclaimer

Nedbank Capital
Table 1 (continued)

GLOBAL

Factors

Outlook at the March policy meeting

Recent developments

Rate
impact

Oil price

International oil prices have been relatively volatile but at vastly lower
levels than those prevailing for much of 2014. The partial recovery in the
international oil price, in conjunction with the recent depreciation of the
rand against the US dollar, and the impending fuel and RAF levies, will
have reversed a large part of the favourable impact on domestic petrol
prices. The international oil price assumption remains unchanged from
the previous meeting, with a moderate increase over the next two
years.

Oil prices have risen by 13.6% since the last MPC meeting in March, and
traded within a wide $54 - $68/bbl range. Recent news of a slowdown in
the US inventory build-up have kept the price of oil supported, however
further dollar weakness and the possibility of Iranian supplies entering
the market has been keeping the price volatile. The higher oil price is
expected to lift the local petrol price further in the coming months. On
an annualised basis however, the oil price is still 39% lower, but this base
effect will reverse in the coming months.

HOLD

SARBs GDP
forecast

The outlook for the domestic economy remains overshadowed by the

electricity supply constraint, which appears to have had an adverse
effect on recent economic activity. The Banks growth forecast for 2015
is unchanged at 2,2%, and marginally lower at 2,3% for 2016. The Banks
leading indicator of economic activity also suggests a continuation of the
sluggish growth outlook.

GDP data for Q1 is expected to be released next week. Nedbank

forecasts 1.7% q/q growth, compared to 4.1% in 2014/Q4. Positive
contributions from the mining and manufacturing sectors are likely,
however this may be offset by deteriorating net exports and lower
consumption spending. The growth outlook remains subdued due to
electricity shortages, high wage demands, and low consumer demand
both globally and locally.

HOLD

Domestic
supply

Both real mining and manufacturing output contracted on a m/m basis

in January; the Kagiso PMI declined sharply to below the neutral 50 level
in February; the RMB/BER business confidence index declined to below
the neutral 50 level in the first quarter of 2015 to 49 points, with the
decline most marked in the manufacturing sector; and the building
sector also shows signs of slowing, with both buildings completed and
new plans passed declining, along with lower confidence in the sector,
particularly with respect to residential construction.

Mining production was up by 18.8% y/y, from 7.5% in February, much

higher than forecasts of +5.9%. Most of the basket saw big increases in
production over the month. The key driver of the 18.8% surge in mining
production was PGMs, contributing 13.1% to the overall growth.
SA manufacturing production printed at 3.8% y/y in March from a decline
of 0.4% (upwardly revised from -0.5%) in February. This exceeded
expectations of 1.0%. The major driver of the annual growth was the
'food and beverages' category which added 1.9 percentage points.

HOLD

Domestic
demand

Growth in final consumption expenditure by households increased

marginally to an annualised quarterly rate of 1.6% in the fourth quarter
of 2014, and measured 1.4% over the year. Both retail trade and
wholesale trade sales declined on a m/m basis in January, and the
outlook remains uncertain as the potential boost to consumption from
lower petrol prices has been partially reversed. High debt levels, low
employment growth and continued tight credit conditions are likely to
constrain consumption expenditure growth in the absence of strong
increases in real disposable incomes or strong positive wealth effects.

New Vehicle sales contracted by 3.3% y/y in April, from no change in

March, worse than forecasts of -0.6%. Sales of passenger vehicles, light,
medium, and extra heavy commercial vehicles contracted, while sales of
busses and heavy commercial vehicles rose.
SA retail sales surged in February, by 4.7% y/y, from 1.9% in January,
beating forecasts of 1.9%. Over the month alone, retail sales surged by
1.9%, from 0.2% growth in January, beating forecasts of 1.2%. The key
upward driver of retail sales was general dealers, which rose by 4.8%
y/y and contributed 2% towards the overall index.

HOLD

Monetary
conditions

Trends in bank credit extension to the private sector have remained

relatively unchanged, with highly divergent patterns in loans granted to
the corporate and household sectors. While growth over 12 months in
total loans and advances to the private sector measured 8,3% in
January, credit extended to corporates increased by 14,3% while that to
households increased by 3,5%. Both mortgage credit extension and
instalment credit and leasing finance reflected slow growth in housing
and motor vehicle sales. Commercial mortgages, by contrast,
experienced buoyant growth.

Private sector credit extension growth rose to 8.9%y/y, higher than the
consensus forecast of 8.5% from 8.7%y/y, driven by credit to companies,
which increased by 2.5%m/m and 13.9%y/y, while extension to
households remained weak, growing by 0.2%m/m and 3.6%y/y. Credit
growth remains subdued for this point of the business cycle. It is likely to
increase only moderately in 2015 as a whole, supported by some
improvement in household finances, although the upside will partly be
contained by the generally weak and constrained economic
environment.

HIKE

Forecast of
inflation

According to the Banks latest forecasts, inflation is now expected to

average 4.8% in 2015, compared with the previous forecast of 3,8%. A
first quarter average of 4.2% is now projected as the low point,
compared with 3.5% previously. The strong base effects in the first
quarter of 2016 are expected to result in a temporary one-quarter
breach of the inflation target during that quarter, at 6.7%, with the
average for the year expected to measure 5.9% compared with 5.4%
previously. Inflation is expected to average 5.5% in the final quarter of
the year, compared with the previous forecast of 5.3%.

Nedbank forecasts inflation to average 4.7% in 2015 and 6.1% in 2016,

differing from SARBs forecasts of 4.8% and 5.9% respectively.
SA CPI rose to 4.0% y/y in March from 3.9% in February, below forecasts
of 4.1% and Nedbank forecast of 4.2%. Core inflation fell to 5.7% y/y
from 5.8% in February, below forecasts of 5.8%. This indicates a broadbased decline in consumer demand, as the core measure excludes the
most volatile items of food and fuel costs. The biggest upward drivers of
CPI were transport inflation and housing and utilities, while food and
non-alcoholic beverage prices eased in March.

HOLD

Market
expectations

Forward rate agreements are pricing in a 13% probability of a 25bp rate

hike at this weeks MPC meeting (or an 6.4% chance of a 50bps cut), a
49% chance of a 25bp rate hike in 3 months time, and a 105%
probability of a 25bp rate hike in 6 months time. As we head closer to
subsequent MPC meetings, the FRA probabilities may tick higher,
reflecting expectations for a hike by the SARB later in the year.

Forward rate agreements are pricing in a 50% probability of a 25bp rate

hike at this weeks MPC meeting, a 122% chance of a 25bp rate hike in 3
months time, and a 210% probability of a 25bp rate hike in 6 months
time. Higher inflation expectations and forecasts of an uptick in US
interest rates are fuelling local interest rate expectations.

HIKE

Food prices

The recent downward trend in consumer food price inflation is forecast

to be reversed in the coming months, following the severe drought in
some of the maize producing areas of the country. With drastically
reduced maize crop estimates, South Africa is expected to become a net
importer of maize during the year, and spot prices have moved closer to
import parity. The spot price of white maize, for example, has increased
by around 30% since the beginning of the year, reinforced by a
depreciating currency and despite moderating global prices. Meat prices
have also remained elevated.

The recent drought has pushed the local maize price higher since the
March MPC, the maize price has risen by 7%. Protein prices remain high,
while the higher transport cost is expected to drive other food prices
higher. This is in contrast to international food prices which have
continued to fall, as indicated by the FAO food price index, which is now
in the 13th consecutive month of decline.

HIKE

Rand
exchange
rate

The rand weakened by around 5% against the USD (and 2.5% on a tradeweighted basis) since the last MPC meeting, and 11.5% y/y (flat on a
trade weighted basis). The market is increasingly pricing in the
possibility of earlier rate hikes by the Fed, due to upbeat labour market
data from the region. This has resulted in significant FX volatility, and a
very upbeat and overbought USD.

The rand strengthened by around 1.11% against the USD (and 1.4% on a
trade-weighted basis) since the last MPC meeting, but remain 14.5%
weaker y/y (4.1% on a trade weighted basis). The rand has remained
highly volatile as a result of the volatile dollar, which is expected to
persist until the US confirms a rate hike.

HOLD

Administered
prices

Administered prices fell into deflation in January and February (currently

-4.5% y/y in Feb). This is because of low transport inflation, with the fuel
price still low on a y/y basis. The petrol price however, has risen by 96
cents in March, and is essentially unchanged from the January MPC
meeting. The price is expected to rise further as a result of the current
under-recovery, and the fuel and transport levies overlaid onto the basic
fuel price. Further, Eskom will likely apply for a 25.3% tariff increase
from NERSA, indicating that price hikes will likely be high in 2015.

Administered price inflation remains negative as a result of the transport

deflation. This is unlikely to be sustained given the multiple fuel price
hikes that weve already had for the year. Since the last MPC meeting,
the petrol price is R2.58/l higher. Also, given expectations for electricity
tariff increases in 2015 and 2016, administered prices are expected to
rise and place upside pressure on headline inflation.

HIKE

Wage
settlements

The Andrew Levy Employment Publications survey shows that during

2014, the average wage settlement rate in collective bargaining
agreements amounted to 8,1%, compared with 7,9% in 2013. The public
sector wage settlement is still not agreed, and the outcome is expected
to have an important bearing on the general trend of wage settlements
in the economy in 2015.

The most recent Andrew Levy wage settlements data indicate that wage
settlements remain unsustainably high and in excess of inflation. This will
weigh on CPI in the medium term.

HIKE

ECONOMY
(20%)
(Contd)

DOMESTIC
ECONOMY
(40%)

INFLATION
DRIVERS
(40%)

Source: SARB, Nedbank

Interest rate barometer | 18 May 2015

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Nedbank Capital
Table 2: Probability of outcomes
Impact
Global economy (20%)

Unweighted Probabilities

Weighted probabilities

Cut

0%

0%

Hold

100%

20%

Hike

0%

0%

Domestic (40%)

Cut
Hold
Hike

0%
67%
33%

0%
27%
13%

Inflation drivers (40%)

Cut
Hold
Hike

0%
25%
75%

0%
10%
30%

Final Result

Cut

0%
62%
38%

0%
57%
43%

Hold
Hike
Source: Nedbank

US inflation expectations move towards 2% target

Higher international oil price likely to place upside

pressure in local inflation

Trade weighted rand supported recently

SA PMI tumbles in April

FRAs tick higher on the back of heightened expectations

for a Fed hike

SA Food prices expected to track maize price higher

Source: Bloomberg, SARB, Nedbank

Interest rate barometer | 18 May 2015

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Interest rate barometer | 18 May 2015

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