South African interest rates look set to rise even further in future after increasing by a cumulative 75 basis points this year. Rate increases will be welcome news to savers but not to the over-indebted.
The rate increases will, however, be moderate and could even be delayed if the current benign inflation outlook continues for longer and interest rates in the US do not go up significantly when they finally do start rising.
The effects of the increases are unlikely to be as severe as in 2014, given that at least in 2015 economic growth should improve and more jobs could be created, which will support spending in the local economy.
The Reserve Bank’s monetary policy committee began the interest rate-increasing cycle in January 2014 amid rising inflation and a selloff in emerging markets assets that saw the rand weaken considerably.
The inflation threat has come down quite significantly since, although risks remain that it could increase again.
These risks include a weak rand, steep wage increases and high administered costs such as electricity tariffs.
Local real interest rates have to rise back into positive territory to keep investors interested in local assets by the time US rates start going up. Most analysts expect US rates to increase in the second half of next year.
Reserve Bank governor Lesetja Kganyago announced at the most recent monetary policy committee meeting that an improvement in the inflation outlook coupled with sluggish domestic economic growth had led the committee to leave the benchmark repurchase (repo) rate unchanged at 5.75%.
He stated, however, that the rate-hiking cycle continued and would depend on a number of
Domestic inflation has been helped by much lower oil prices
factors, including how inflation performed over the next year or two, and on economic growth. He also confirmed that US interest rate increases would play a role.
The Reserve Bank said the rand exchange rate had been relatively volatile since September in response to matters such as expectations around the timing of interest rate increases in the US and Moody’s downgrade of SA’s sovereign credit rating. The monetary policy committee expects inflation to average 6.1% this year from an earlier projection of 6.2%, 5.3% next year from 5.7%, and 5.5% in 2016 from 5.8% before. Inflation is forecast to reach a low of 5.1% in the second quarter of 2015.
Domestic inflation has been helped by much lower oil prices. Brent crude oil prices have dropped from about $112/barrel in June to four-year lows of around $78/barrel. This has helped lower local fuel prices and eases the pressure on inflation. Lower global food prices have in recent months also offered support and helped ease domestic inflation. But indications are that this could change, and coupled with rand weakness could spell disaster for inflation in 2015.
The October UN Food and Agriculture Organisation’s food price index averaged 192.3 points, which was 0.2% below September’s figure.
What raises concern, however, is that the cereal price index showed that international prices of wheat and coarse grains firmed slightly in October after five months of steep falls, owing mainly to maize harvest delays in the US and deteriorating wheat prospects in Australia.
The index measuring meat prices fell 2.3 points to average 208.9 points in October, although more data showed that quotes for most types of meat were still at historic highs.
Rates need to rise to keep investors interested in SA’s yield advantage when US interest rates start to increase — something that is expected to happen in the second half of 2015, if not earlier.
SA remains behind the curve compared with its peers regarding its interest rates, which are slightly higher in countries like Brazil and Turkey.
This puts SA at risk of losing out on investments, because investors are in the business of
chasing yield. If the rate of return on investment is higher in Brazil than in SA, that is where investors will invest.
Brazil’s central bank raised the Selic benchmark interest rate to 11.25% in October from 11% to “ensure, at a lower cost, the prevalence of a more benign outlook for inflation in 2015 and 2016”. This 25 basis points rate increase was the fourth in 2014 and was focused on addressing high inflation. Inflation in twelve months reached 6.75% in September, compared with 5.86% in September 2013. The central bank of Turkey left its benchmark one-week repo rate steady at 8.25% in November despite high inflation and a weak lira.
Citibank economists said that despite the challenging external and domestic backdrop in Turkey, that country’s central bank was likely to maintain “its opportunistic approach” in the conduct of monetary policy. This, they said, boiled down to the central bank tightening its stance and language when the lira came under pressure and markets became “skittish”, and relaxing the stance through either providing more liquidity or cutting rates when the lira and global conditions permitted.
Indications are that SA will not be the only country that will continue raising interest rates, even though this will happen in an environment where economic growth is forecast to be much better than it was in 2014.
The South African economy is expected to start growing faster in 2015 although by rates that are still far below those needed to address the country’s challenges of high unemployment and poverty. The Treasury expects the economy to grow by 2,5% in 2015, the same forecast as the Reserve Bank’s.
The forecasts are slightly more optimistic when compared with the International Monetary Fund’s 2.3%.
These growth rates are lower than the more than 5% per year identified in SA’s vision 2030 policy framework, the National Development Plan.
One of the factors that will lift growth next year is higher global economic growth, which will boost demand for local exports. An increase in export volumes, coupled with a slowdown in import growth given weak domestic demand, would also help narrow the deficit on the current account and cause the rand to firm slightly.
Local demand is, however, unlikely to shoot the lights out given that conditions for households — whose spending accounts for over 60% of local expenditure — will remain tough.
Interest rates will continue rising and so will administered prices, such as water and electricity.
Electricity tariffs will no longer go up by the 8% the energy regulator initially granted power utility Eskom, but by 12.7%. This increase is just for those whose electricity is supplied by Eskom. Municipalities are likely to charge more.
Eskom’s ability to bring a unit at the Medupi power plant, which is under construction, into operation, will also have an effect.
Power supply constraints have weighed on business confidence and have been highlighted by rating agencies as a deterrent to economic growth.
Interest rates will continue rising and so will administered prices such as water and electricity
Eskom said recently it was “working around the clock” to deliver Medupi’s unit 6 by the end of this year.
If Eskom indeed delivers on time, this will pave the way for companies to produce, employ more people and contribute to higher economic growth.
Potentially more growth-damaging are strikes, which cost the economy billions of rand in lost revenue and subdued output.
Reasons for the growing impatience among workers and their demands for steep wage increases include the rising costs of living and under-pressure disposable incomes.
Unions representing public sector workers are going back to the negotiating table as their current wage agreement will expire in March next year.
Some unions have already indicated they intend to start negotiations at 15%, while the government has hinted at single-digit wage increases, preferably in line with inflation or 1% above it.
Government finances are under pressure and the state is already trying to cut costs, which is an indication that double-digit increases are unlikely.
The Reserve Bank has already warned that wage increases well in excess of inflation would be undesirable as they pose a risk to inflation.
A strike by public servants, even one lasting a month, will be economically damaging. It will require a lot of understanding on the part of public servants to put SA Inc first.