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BoZ opts to keep policy rate unchanged to support the economy

February 17, 2022by Nicholas Kabaso
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Local Market Commentary

  • The Bank of Zambia yesterday kept its benchmark interest rate unchanged at 9.0% to further support the economy after inflation slowed to a two-year low. According to Governor Denny Kalyalya, the decision to hold was supported by a “sharp decline in inflation since December and due to some fragility in economic growth. The Monetary Policy Committee (MPC) forecast the economy to grow 3.5% in 2022 and 3.6% in 2023. 
  • Regarding inflation, the MPC forecast price growth will continue to trend towards its 6% to 8% target range over the next eight quarters. According to the Governor, this is “mainly due to the catalytic benefits of securing an International Monetary Fund program such as access to budget support, a reduction of external debt burden through restructuring and unlocking investment.” The MPC now forecasts inflation to average 13.2% this year versus 15% projected at the November meeting. That said, upside risks to the inflation outlook exist. These include adverse weather conditions, supply chain bottlenecks, surging energy prices, an anticipated increase in power tariffs, and a weaker Zambia Kwacha (ZMW).
  • Zooming in on the ZMW, it has been the worst-performing African currency on a year-to-date basis, down by almost 6.00%. Much of the ZMW weakness can be attributed to tight FX liquidity conditions. Demand for hard currency from importers and the corporate on the back of improving economic activity has outpaced available supply and thus weighed on the local unit. As mentioned in previous commentary, the ZMW rally was in part driven by sentiment, and economic fundamentals remain the same at present. This, therefore, suggests that the current level of undervaluation of the ZMW on a real effective exchange rate basis is justified. Looking ahead, the bullish copper outlook notwithstanding, further room for appreciation will likely depend on the new government making significant headway in implementing the required economic reforms and addressing the existing structural challenges.
  • Today, there are several data releases with the US housing starts and building permits being the major release of interest. Both data prints surprised to the topside in December, confirming that recovery in the housing market remains intact and that the credit cycle remains robust. A further improvement in the housing market could continue contributing positively to household balance sheets as prices rise. This will corroborate the case for the US Fed to begin normalising.
  • There were no surprises in yesterday’s FOMC minutes, with the central bank still pointing to a measured tightening in monetary policy. The FOMC is likely to decide on a rate hike in March, although it is not evident that the rest of the FOMC feels as strongly as Fed President Bullard that a 50bp rate hike is needed. The risk for the Fed is that they move too aggressively too quickly and impose unnecessary headwinds on an economy when inflation will naturally reverse over time in any event.
  • The USD remains on the defensive. The VIX has dropped further, and overall risk appetite has improved considerably. The safe-haven bid has lifted, and the USD is struggling to hold on to its gains now that the FOMC alluded to a measured approach to tightening. EM currencies appear to be on the front foot this morning, and equity markets look a little more stable. All eyes remain on Ukraine, but for now, there is no definitive news to trade on, and investors continue to believe that the geopolitical tensions will eventually be resolved.

Rand and International FX Commentary

  • Two more risk events were cleared off the decks yesterday, leaving investors to focus on next week’s budget. Overnight, the FOMC minutes delivered no new surprises and reiterated that the Fed was ready to hike rates and reduce the size of its balance sheet later this year. The important point here was that the rate hikes would take place at a measured pace, pouring cold water on recent talk of a 50bp hike in Mar in line with St Louis Fed President Bullard’s comments.
  • On the domestic inflation front, consumer prices moderated in January, coming in at 5.7% y/y from 5.9% y/y in December. According to Stats SA, inflation moderated for the first time in three months due to lower prices for food and non-alcoholic beverages, housing and utilities, transportation, and other goods and services. However, quickening core inflation will continue to be a source of concern for policymakers, having risen from 3.4% y/y in December to 3.5% y/y in January. The market reaction was modest, with the USD-ZAR hovering just above the 15.00-handle. While inflation will remain contained on the back of relatively tight monetary dynamics, there is a possibility that inflation breaches 6% in Q1, given expectations for food and energy prices to remain elevated. Note that this will partly be determined by the ZAR’s performance in the coming weeks.
  • It confirms that domestic rate hikes will, at a minimum, keep pace with US rate hikes and have already pulled ahead given the last two rate hike meetings, with more to come. The SARB’s conservative stance will induce greater resilience on the ZAR, which is already evident in the ZAR’s resilience score that ranks in the top half of a twenty-two country sample. Equally, SA bond yields confer a degree of attractiveness that will keep the ZAR well supported as the ZAR ranks third from the top of the same twenty-two country sample.
  • The ZAR’s recovery may surprise many people but is in line with the country’s underlying fundamentals relative to other countries in the world. While many concerns are doing the rounds in SA, other countries face their own challenges. Furthermore, SA as a commodity producer enjoys some support and tailwinds that most other currencies do not and for as long as commodity prices remain elevated, and risk appetite improves, the ZAR will enjoy improved performance.

Nicholas Kabaso

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