Rate hike: a matter of how much next

THE hike in interest rates late in January caught most economists off-guard because the economy was regarded as too weak for the Reserve Bank’s monetary policy committee to even consider tightening the bolts on struggling consumers.

But, with warnings that the costs emanating from a weak exchange rate this year would increasingly be passed on by retailers to shoppers and by virtue of its inflation-targeting mandate, the committee had to act. And so the Reserve Bank’s repo rate was lifted (by 50 basis points to 5.5%) in January for the first time under the watch of governor Gill Marcus.

Marcus has made it clear since then that monetary policy is on a tightening curve. The committee’s post-meeting statements in March and May indicated that its actions would be strongly influenced by inflation data and expectations.

The key issue is that real interest rates are too low. With the consumer price index rising by 6.1% year on year during April and the repo rate at 5.5%, interest earned on savings and in the money market will not keep up with inflation.

Since Marcus took office in mid2009, this 0.6 percentage point gap between the repo and inflation rates has averaged a positive 0.35 percentage points, the repo rate being on average higher than headline inflation.

The question now is: How will the dice roll when the monetary policy committee meets in July, September and November? At the May meeting, policymakers voted five against two to keep the repo rate unchanged, signalling a hesitance to tighten monetary policy further.

Adding more uncertainty over the size of the next interest rate adjustment is the fact that Marcus has signalled a few times this year that a 25 basis points adjustment is definitely possible. This is significant, because the Reserve Bank has typically cut the rate by 50 basis points at a time. In fact, the last time the repo rate was cut by less than 50 basis points was in the turbulent times of mid-2001.

The split in the vote in May makes for some interesting theorising among economists. After all, previous monetary policy committee decisions were said to be a “consensus view”.

The latest Reuters Econometer survey, released on May 15, indicated that economists did not expect a change in the repo rate during May, which was indeed the case. The median forecast is for the repo rate to rise by another 75 basis points by year-end, but economists are far from reaching a consensus on how this will transpire.

About half of the respondents to the Reuters poll still see 50 basis point increments being implemented by the monetary policy committee, and the remainder are comfortable in heeding Marcus’s warning about 25 basis point adjustments. In light of disappointing economic growth data for the first quarter of 2014, the latter appears increasingly likely.

Looking beyond this year, a recent Bloomberg survey asked economists where they expected the repo rate to be at the end of 2016. Most agreed that a reading of 7% — 1.5 percentage points above the current level — will be a likely level.

From a listed company perspective, there is no real good news for the JSE when projecting an upward curve in interest rates over the next few years. Tighter monetary policy will clearly weigh on the earnings of consumerrelated companies.

Retailers offering in-store credit, automotive retailers and companies involved in real estate will have to deal with more indebted consumers, higher financing costs and more expensive mortgages, respectively, all of which will hamper sales. Examples of companies in these sectors are furniture group Steinhoff, motor vehicle franchise holder Barloworld and Africa’s largest lender, Standard Bank.

Some might argue that financial institutions — for example, Barclays Africa Group (formerly Absa) and Capitec (one of the country’s biggest unsecured lenders) — will benefit from higher margins by being able to charge higher interest rates. Although this is certainly true, the adverse impact of slower economic activity and increased repayment defaults could easily undo this potentially positive effect.

Viljoen is a senior economist at NKC Independent Economists