Why the SARB is in a hiking cycle
We look at what the Reserve Bank has in store for the local economy in the coming months, and why.
the South African Reserve Bank’s (SARB’s) primary mandate is to achieve and maintain price stability in the interests of balanced and sustainable growth. Price stability is a necessary but not a sufficient condition for economic growth that South Africa requires. To achieve price stability, the SARB has an inflation target of between 3% and 6%. The adjustment of interest rates is the main policy tool used by the SARB to ensure that inflation stays within the stated target.
Last year, SA’s consumer price inflation grew by 6.1% compared to 2013. It was a tale of two halves. Inflation slowed in the latter half of 2014 and slowed even further in 2015, averaging only 4.1% during the first quarter. This was on account of the significant decline in the oil price, which led to a decline in the domestic petrol price. After bottoming at a rate of 3.9% in February, consumer inflation has increased to 4.6% in September.
We expect inflation to increase further in the coming months, peaking at around 6% during the first and final quarter of 2016. The main sources of the expected acceleration in inflation are cost push in nature. They are a higher rand oil price, further increases in electricity prices and higher food prices.
In contrast, the South African economy has delivered very weak growth in the last two years and we expect this to continue over the next two years. Last year the South African economy grew by only 1.5% with consumer spending only growing by 1.4%. With government making an effort to rein in its budget deficit, weak growth in credit extension to households and supply side constraints such as electricity holding back domestic output, we expect the South African economy to continue to deliver weak growth. As a result there will be limited demand-led drivers of inflation.
Despite this we expect the SARB to raise the repo rate by at least 50 basis points (0.5 percentage point) over the next 12 months for the following reasons. Firstly, as has already been explained, inflation is likely to increase somewhat over the next few months. Secondly, the risks to the inflation outlook are to the upside. We are a small open economy with a large current account deficit. This means our national spending is significantly greater than national income. The difference needs to be borrowed.
With the US Fed about to begin raising interest rates for the first time since 2008, funding for countries that need it, like SA, will become more expensive. This partly explains the significant rand weakness we are currently witnessing. The rand is likely to weaken further when the Fed does raise rates.
Rand weakness could place further upward pressure on inflation than is currently anticipated as second-round inflationary effects, which have been largely absent, come to the fore. There are also concerns about what a long period of high inflation will do to inflation expectations that are at the top end of the 3% to 6% target and on the pricing behaviour of both labour and firms.
We expect the SARB to act against these risks in a gradual manner and to do so pre-emptively.
We expect inflation to increase further in coming months, 6%peaking at around during the first and final quarter of 2016. Last year the South African economy grew by only 1.5% with consumer spending only growing by 1.4%.
The headquarters of the South African Reserve Bank in Pretoria.