Arthur Kamp: Chief Economist at Sanlam Investments
The Reserve Bank increased its repo rate by 50bp to 8.25% at the conclusion of its Monetary Policy Committee (MPC) meeting yesterday, underlining its inflation fighting credentials. At the same time, although consumer inflation is expected to slow from its current level of 6.8%, the Bank lifted its headline CPI forecast for a year out in 2Q24 to 5.3% from 5.0% previously. It also signaled that inflation risk is skewed to the upside. This leaves the door open for possible future interest rate hikes.
Two of the most significant risks to the interest rate outlook are changes in the Rand and the outcomes of upcoming US FOMC meetings. Recent developments in the currency market are especially important. Rand depreciation can feed through into significant so-called second round effects whereby the initial impact of higher import prices on inflation is amplified by higher production costs and / or wage demands. It is, therefore, concerning that the Bank warns: “given upside inflation risks, larger domestic and external financing needs, and load-shedding, further currency weakness appears likely”.
To be clear, the Bank responds to the inflationary impact of Rand weakness, rather than movements in the exchange rate itself. However, the situation is worrying, especially since loadshedding is driving up the cost of doing business, while food price inflation is expected to remain high. In this environment second-round impacts could be significant.
At the same time, the US Federal Reserve matters as demonstrated by the tightening of global financial conditions, which is partly responsible for softer foreign capital inflows into South Africa. Although stresses in the US banking system are likely to keep the US FOMC on hold when it meets in June 2023, the ongoing tightness of the US labour market and the relative stickiness of US core CPI may lead to another US interest rate hike in July 2023.
South Africa has not fared well against this backdrop. In the end, as illustrated this month, the fundamental underlying problem is a balance of payments constraint. Net foreign capital inflows, deterred by low prospective returns, policy uncertainty and a lack of infrastructure have been insufficient to fund the current account deficit. This implies macroeconomic policy must be tightened. South Africa’s pressing socio-economic problems and the failure of specific state-owned companies have precluded aggressive fiscal policy tightening. Hence, the onus has been on the Reserve Bank to do the heavy lifting.
Overall, it cannot be guaranteed that we have reached the top of the interest rate hiking cycle. Much will depend on developments in the Rand and its potential inflation implications, while the Bank is also keen to see elevated inflation expectations moderate.
Even so, despite the risks, this may still be the case. The currency has depreciated a long way, while the interest rate hiking cycle is far advanced. At some point this is likely to have the desired effect. As 2023 wears on the focus may shift from interest rate worries to economic growth worries.
Also, historically, the interest rate hiking cycle has typically ended once it is clear inflation has peaked and is heading decisively towards the intended target. On current information, we think we are approaching that point.