MPC has tough choices with economy tanking
Interest rates are expected to rise by at least 25 basis points. By
The Monetary Policy Committee (MPC) of the South African Reserve Bank is widely expected to raise interest rates by at least 25 basis points next week when it concludes its three-day meeting on Thursday, 30 March.
A Reuters poll published on 20 March forecast the MPC would increase its key repo rate by 25 basis points and then take its finger off the trigger on expectations that inflation will slow in the face of an economy battered by power shortages.
It would be the ninth consecutive hike since November 2021, adding a cumulative 400 basis points since then and taking the repo rate to 7.50% and the prime lending rate to 11.0%.
But the Reserve Bank – not for the first time – finds itself between a rock and a hard place. A bigger-than-expected hike is not inconceivable, and this may not be the end of the tightening cycle.
The rand’s performance this year will certainly be in focus. When the MPC last met to deliberate on rates in late January, the rand was trading at around 17.13 to the dollar. It has since lost ground, to above 18.50/$. On 23 March, it firmed back below 18.20/$. That rally partly reflected the fact that the currency has strayed deeply into “oversold territory”, according to technical signals.
It was also in response to dovish comments from the US Federal Reserve, which raised rates on 22 March by a further 25 basis points – its ninth straight hike to contain inflation – while signalling that its tightening cycle may be nearing the end.
US rates are now in a 4.75% to 5.0% range and one of the key bases of support for the rand is the spread between US and South African rates. If the Fed is taking its foot off the pedal, that gives the Reserve Bank space to do the same.
This backs the case for the Bank to raise rates by 25 basis points and then call it a day. The MPC will also be mindful of the impact that bigger rate rises will have on an economy that is going down the drain.
The International Monetary Fund on 22 March slashed its 2023 GDP growth forecast for South Africa to 0.1% from 1.2% because of the surge in power cuts. In the fourth quarter of 2022, the economy shrank by 1.3%. And it may well be contracting again this quarter, which would mean it is officially in a recession.
Confidence on the business and consumer fronts is collapsing. The FNB/BER Consumer Confidence Index (CCI) plunged to -23 index points in the first quarter of this year, down from -8 index points in the fourth quarter of 2022.
“The reading of -23 is the third lowest CCI reading on record since 1994 and indicative of extreme concern among consumers about South Africa’s economic prospects and their household finances,” FNB said.
But the MPC will also be concerned by the latest inflation data, which shows that price pressures are not ebbing.
South Africa’s consumer price index (CPI) accelerated on an annual basis to 7% in February, from 6.9% in January, exceeding market expectations of a 6.8% rise. Consumer inflation remains well above the Bank’s 3% to 6% target range.
Worryingly, prices for food and nonalcoholic beverages increased by 13.6% in the year to February, the highest reading since April 2009. This underscores the severity of the cost-of-living crisis that is exacting its biggest toll on poor and working-class households, with the middle class also feeling the pinch.
Much of this is being driven by the power crisis, which monetary policy can do little to address. Food production chains have been severely disrupted by power cuts, and producers pass the costs on to consumers.
Still, the Bank’s view has long been that inflation erodes household incomes and wealth, and the best tonic for that is measures to contain it.
With this in mind, one likely scenario is that the MPC hikes by 25 basis points but adopts a hawkish tone in its statement that suggests this might not be the peak. Such a stance would help, to use central bank lingo, to “anchor inflation expectations”.
Of course, it’s not ideal to hike interest rates during a possible recession in an economy that has almost no short-term growth prospects. But accelerating inflation of 7% is also not ideal, nor is a rand that remains over 18/$. There’s simply nothing ideal about the South African economy or the Reserve Bank’s policy options.