Reserve Bank raises Interest Rates

The South African Reserve Bank’s (SARB) surprise 50 basis point interest rate increase this afternoon has opened the door for further rate hikes, economists warned. Emerging market economist Peter Attard Montalto said he sees the hike as the start of a 200-250 Basis Points hiking cycle that should be completed by the middle of 2015. He expects the latest hike to be followed by another two interest rate increases this year, most likely in the second half of the year.

“This move considerably increases the monetary policy committee’s (MPC) credibility… many thought it would not adhere to its mandate and would be overly political,” he said. The move suggests that the Sarb’s MPC “is indeed orthodox and conservative”, he said.

h3. SARB backed its forecasts

Economist at Sanlam Investments Arthur Kamp shared this sentiment, stating that the SARB had backed its forecasts. “The general expectation was that the SARB would hold interest rates steady. “After all, domestic demand is soft, credit extension growth has been modest and the core inflation rate has been stable at 5.3% for the last four months of data up to December 2013.”

Kamp said after plugging a weaker rand into its models, the SARB’s medium-term inflation forecast increased markedly (to an average of 6.3% and 6.0% for headline CPI in 2014 and 2015 respectively). The forecast is significantly above the consensus expectation. “However, the forecast should be viewed as reasonable if the SARB does not expect material appreciation of the currency anytime soon.

h3. Currency Pressure

“The Rand’s fall has been especially sharp and history suggests feed-through effects to inflation can be significant in such cases.” Kamp said the decision is a direct response to the expected impact on inflation from the weakness of the Rand. “The question now is: how will the currency react? “If the rand remains relatively weak for an extended period, further interest rate increases could follow.”

Grindrod head of asset management Paul Stewart said the increase occurred in part because several other emerging economy central banks hiked short-term interests rates. “They did this to protect falling exchange rates against the US dollar, Euro and British pound, which forced the SARB’s hand to an extent.”

h3. Strain on Consumers

“If we see another 50 to 100 basis point [increase] in the next three months, that will begin to mount pressure on consumers,” he said. The increase arguably marked the start of a gradual rate tightening cycle that could last three to four years, said Grindrod. Montalto said the move today sends some very strong signals to the market. He said the SARB is an inflation and inflation pass-through risk targeter. “Many in the market thought it was more interested in growth.” “It is not the MPC’s job to sort structural growth problems,” he said.

h3. Long in the Making

“So even though it expects growth to be weak it can still hike rates. We think the MPC took a firm view on this over a year ago. “The SARB is indeed conservative and orthodox. It is not trying to do anything dramatic here.” He said the hike is not intended to backstop rand, but only to reduce pass-through. “The MPC is not as political as many thought. Even we thought May made more sense given the election, but such timing concerns being overridden shows the main concern is inflation.

Montalto said that many market participants thought the MPC was so focused on politics that it would not be able to hike this year. “The SARB may well be criticised about communication after this surprise move but we think its thinking, and its development through the last 18 months, has been very clear. “We don’t think the moves by other emerging market central banks would have primarily caused the hike. Instead, we see the move as the culmination of a long strategy that is ultimately domestically focused.

We just say: Thank you to the Unions and their Co-Culprits in Government!

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