Comes Thursday – can we take another Rate Hike?

A survey by Reuters two weeks ago has found that most SA economist expect that interest rates will increase by another 50 basis points, with nearly half expecting a hike after the Reserve Bank’s monetary policy committee meeting this week. The Reserve Bank hiked its repurchase rate in February from 5% to 5.5%, which led commercial banks to increase prime lending rates from 8.5% to 9% due to continued inflationary pressures.

The inflation rate has been close to the upper limit of the 3% to 6% inflation target range during the last few months and the decline in the rand has given rise to expectations that inflationary pressure will continue. Production price inflation has also increased in recent months, indicating higher consumer inflation once these price increases work through retailers’ delivery systems to the prices on their shelves.It seemed that the Reserve Bank has decided to counter inflation early and immediately started to increase interest rates. And more increases are expected. Most of the economists in the Reuters survey expect at least two similar increases within the next 12 to 18 months, with a few expecting these increases before the end of the year. These increases will up banks’ prime lending rate – the benchmark rate which determines how much interest individual clients must pay – to 10.5%.

If these predictions become a reality, the prime lending rate will increase from 8.5% to 10.5% within a year. The effect on already stressed consumers will be significant. It is difficult to accurately define what an average family’s finances look like. Suffice to say that a mortgage bond of R1m and some car and credit card debt of another R200 000 is quite common. Such a family will see its interest cost increase from R102 000 per annum to R126 000, or from R8 500 per month to R10 500 per month. That is R2 000 less for groceries, movie tickets and restaurant meals.

It is interesting that several economists have recently warned the Reserve Bank against a too aggressive policy of hiking interest rates, pointing to the fact that consumer spending is currently very important in keeping the economy going. The Reserve Bank’s latest quarterly bulletin shows that the export sector is performing far below its potential due to low demand for commodities from the rest of the world and lower production due to disruptive strikes in the mining sector.
Manufacturing production has also been under pressure due to strikes, although it has recovered somewhat in the last few months. Not that consumer spending is that high. The Reserve Bank says that spending by consumers increased only marginally, and mostly on durable imported products as consumers were probably thinking of buying these goods before price increases if the rand continues to depreciate.

In total, consumer expenditure is currently increasing at a much slower pace. In the first quarter of 2012, consumer spending were growing at 3.6% (an annualised rate), but declined quarter after quarter since then. Latest available figures, for the third quarter of last year, show that growth in consumer spending has slowed to 2.3%. There seems to be enough reason for concern from economists that fragile economic growth is in danger of being killed by high interest rates before the international economy recovers to stimulate exports.

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