Hawkish SARB MPC hikes amidst upside inflation risks

By Arthur Kamp, chief economist at Sanlam Investments

At the conclusion of its Monetary Policy Committee (MPC) meeting on Thursday, the South African Reserve Bank (SARB) increased its repo rate by 50 bps to 8.25%, underlining its inflation-fighting credentials. Although consumer inflation is expected to slow from its current level of 6.8%, the bank has lifted its year-ahead headline CPI forecast for Q2 2024 to 5.3% from 5.0% previously. It also indicated that the 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 rand moves and decisions taken in upcoming US Federal Open Market Committee (FOMC) meetings. Recent developments in the currency market are especially important. Rand depreciation can feed through into significant so-called second round effects, when the initial impact of higher import prices on inflation becomes amplified by higher production costs and / or wage demands. It is concerning that the bank warns: “Given upside inflation risks, larger domestic and external financing needs, and load shedding, further currency weakness appears likely”.

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 load shedding 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, US Federal Reserve decisions are important, as demonstrated by the tightening of global financial conditions. This is partly responsible for softer foreign capital inflows into SA. Although stresses in the US banking system are likely to persuade the FOMC to keep interest rates on hold when it meets in June 2023, the ongoing tightness of the labour market and the relative stickiness of core CPI may result in another US interest rate hike in July 2023.

SA has not fared well against this backdrop. As illustrated this month, the underlying problem is a balance of payments constraint. Net foreign capital inflows, deterred by low prospective returns, policy uncertainty and lack of infrastructure, have been insufficient to fund the current account deficit. This implies macroeconomic policy must be tightened. SA’s pressing socio-economic problems and the failure of specific state-owned companies have precluded aggressive fiscal policy tightening. This has shifted the responsibility onto the SARB to do the “heavy lifting”.

It is by no means certain that SA has reached the top of the interest rate hiking cycle. Much will depend on developments in the rand and its potential inflation implications, while the SARB is also keen to see elevated inflation expectations moderate. However, the currency has depreciated significantly, while the interest rate hiking cycle is far advanced. At some point this is likely to have the desired effect. As 2023 progresses, the focus may shift from interest rate worries to economic growth worries.

Historically, the interest rate hiking cycle has typically ended once it is clear inflation has peaked and is heading decisively towards the intended target. Based on current information, we believe SA is approaching that point.