South Africa:SARB preview -a compelling case for a May hike

　　We expect another 25bps hike to 7.25% on Thursday.

　　Admittedly the SARB may have room to pause, afforded by ongoing downsiderisks to global growth, the rand’s generally stronger trend since the start of theyear, and improving inflation momentum. However, none of these reasons areconvincing enough, in our view. Firstly, there is a one-off effect behind therecent drop in inflation. Overall, inflation risks remain high and recent volatilityand pressure on the exchange rate and oil prices provide no comfort. Asreiterated by the SARB in April1 “over the long run South Africa’s growthprospects are best served by keeping inflation within the target range, and notby looking to exploit a temporary trade-off between growth and inflation.”Inflation risks have not dissipated.

　　Inflation expectations have not deteriorated as such, but remain anchored atuncomfortable levels slightly above the target band. So long as inflation risksare high or rising, the SARB will be worried that inflation expectations couldbecome unhinged. Food inflation pressure continues to surprise to the upsideas the drought’s impact has intensified. February’s inflation surprise, which asdriven by higher-than-expected food inflation, was not incorporated into theBank’s profile either. At the time, the SARB expected food inflation to peak at11.6% in 4Q16. Food inflation already struck 9.8% yoy in March and we expect11% for April (due Wednesday). In turn, high wage demands amid slowproductivity growth could prorogate inflation further. This year’s wage round isyet to get into full swing with the platinum and auto sector’s negotiationskicking off mid-year. However, those currently underway in the parastatalsector (eg SAA, SANRAL and the Post Office) have not started off on a goodfooting. Figure 2 illustrates the substantially higher inflation rates facing lowerincome groups. Finally, the sharp decline in core inflation in March to 5.4%was driven by a one-off effect after the President scrapped university feeincreases this year. Underlying inflation pressures continue to gain traction.

　　Underlying fx pressures continue to rise in core goods prices.

　　Judging from the rise in our measure of core goods inflation, fx pass throughhas accelerated since the start of the year. The rise in overall core inflation wasinterrupted in March by the zero-increase in university fees. As a result thedecline in core inflation to 5.4% in March (from 5.7%) was driven by amoderation in services inflation (70.6% of the core basket) to 5.5 % (from5.9%). In turn, core goods inflation accelerated to 5.4% (from 5%) and shouldrise further to 5.7% in April (due Wednesday, DBe headline CPI 6.3% yoy).

　　Key risks which make the rand vulnerable in months ahead.

　　It is premature to think that the recovery in the exchange rate this year willpositively affect the inflation risk profile, unless it’s sustained beyondexpectations. Uncertainties over the Fed’s policy action, the UK’s EU vote, andthe domestic sovereign credit reviews all due next month require a high degreeof attention. China’s financial system risk posed, in part, by strong creditgrowth is also reviving hard landing risks. Now that global growth concernsare re-emerging, EMFX, especially with high betas to S&P and China couldcome under renewed pressures (Figure 3). None of these risks are reassuringas they could lead to more macroeconomic uncertainty and risk aversion.