G LOBAL M ARKETS

Strategic Research | South Africa 15 September 2017

Interest Rate Barometer

Executive Summary
The interest rate barometer considers the factors influencing the decision
Nedbank CIB Research
of the SARBs Monetary Policy Committees last meeting on 20 July 2017 as
Reezwana Sumad
+27 11 294 1753 well as developments since the last meeting (which, in our view, could
ReezwanaS@Nedbank.co.za 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
www.nedbank.co.za/researchportal 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 weeks 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 SARBs
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
GLOBAL Growth The global growth backdrop remains positive, with sustained
upswings evident in most regions. This is despite continued
ECONOMY
uncertainty regarding economic policy reforms in the US.
(20%)
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.
Inflation Underlying global inflation trends remain benign, with inflation
and interest below target in most of the advanced economies,
rates 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.
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 Banks 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.
Recent developments Rate
impact
In its July 2017 World Economic Outlook Update, the IMF HOLD
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.
Inflation in developed markets have surprised recently, HOLD
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.
The oil price trended higher since the last MPC meeting HOLD
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.
 Table 1 (continued)
Factors SARB outlook at the July policy meeting
DOMESTIC SARBs GDP While positive growth is expected in the second quarter, the Banks annual
ECONOMY forecast growth forecasts have been revised down further. The forecast for 2017 has been
(40%) 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.
Domestic Monthly data for both the mining and manufacturing sectors in April and May
supply 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.
Domestic Consumption expenditure by households contracted in the first quarter of this
demand 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.
Monetary These consumption trends are mirrored in the continued moderation in credit
conditions 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.
Forecast of The Banks forecast for headline CPI inflation has shown a marked improvement
inflation 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.
Market The FRA curve is highly compressed, and driven by a surge in foreign investor
expectations 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.
INFLATION Food prices Food price inflation is also expected to be more subdued, due to a lower starting
DRIVERS point and more favourable domestic crop estimates. Despite a persistent upward
(40%) 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%.
Rand While the rand is more or less unchanged since the previous meeting of the MPC,
exchange it has been relatively volatile, having fluctuated in a range between R12.60 and
rate R13.60 against the US dollar.
The rands 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.
Administered These recent oil price trends, along with the stronger exchange rate, contributed
prices 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.
Wage Wage trends have been an important contributor to the persistence of inflation at
settlements 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.
Source: SARB, Nedbank
Interest rate barometer | 15 September 2017
Recent developments Rate
impact
While SA GDP growth rebounded to 2.5% qoq in 2Q17, this was off the CUT
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.
SAs mining production growth came in at 0.9% yoy in July 2017, from CUT
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.
Total new vehicle sales rose by 6.7% to 49,222 units, boosted by a jump in HOLD
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.
Private sector credit extension (PSCE) growth was unchanged at 5.7% yoy, CUT
lower than the markets 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.
CPI has fallen below consensus in five out of the last seven months. In the CUT
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 SARBs forecast in the last two quarters and is expected to fall
below the SARBs 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 baskets subcomponents falls below the
6% target, with this proportion expected to rise in coming months.
The FRA market has been driven by investor complacency in recent CUT
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 SARBs meeting next week and a 133% probability of a cut
by November 2017.
Food inflation eased to 6.8% yoy in March 2017, due to lower maize and HOLD
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.
Since the last MPC meeting, the rand weakened by 1.4% against the HOLD
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.
Since the March 2017 policy meeting, the local petrol price rose by CUT
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.
Inflation expectations currently average 5.9%. Real wage growth per HOLD
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.
Page 2 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 3 of 4

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Interest rate barometer | 15 September 2017 Page 4 of 4