Rand’s rout likely to sway rates call

Reserve Bank may try to mitigate Fed hike fallout

THE Reserve Bank will almost certainly raise interest rates this week to mitigate the effects of the capital flight and currency depreciation likely to take emerging markets by storm if the US central bank starts tightening monetary policy next month, as expected.

The trend has begun, with the rand descending to a record low of R14.38 against the dollar on Monday after news on Friday that US jobs rose more sharply than expected in October. That was seen by financial markets as a signal the Federal Reserve would raise interest rates at its next meeting, which ends on December 16.

Analysts warn that the rand will continue to weaken in the near term whether or not the bank’s monetary policy committee raises the repo rate after its deliberations this week — but the prognosis is far worse if it keeps it steady. The currency is likely to break through the R15to-the-dollar level next year, they maintain.

Although the bank’s main mandate is to target inflation, rand weakness fans price pressures, and capital flight could also undermine financial stability, which it must also protect. Even though the economy is weak, the committee may have little choice but to raise its repo rate by 25 basis points to 6.25%.

“Interest rates need to rise, and will rise,” said ETM Analytics investment analyst Rob Price. “There is room to create an excuse and delay hikes, but then there would be a risk that the rand gets disciplined and rate hikes going forward will be worse.” Local money markets are pricing in a 70% probability of a rate hike this week.

Barclays Africa currency strategist Michael Keenan said he believed many investors had been reluctant to get out of the entrenched “carry trade” — the positive interest rate differential — that has benefited emerging markets for so many years.

That indicates that further unwinding of their positions could take place very rapidly, and at the last minute — an outcome that the monetary policy committee has previously said it is taking into consideration. “Foreign investors reduced their holdings of domestic bonds from 38% in July last year to 33% at the end of September. It’s been gradual, not a bloodbath,” Keenan said.

South African markets have not been shaken too badly by mounting speculation on the timing of a US rate hike because the Reserve Bank has already raised interest rates by one percentage point since January last year, and has repeatedly said it is in a gradual process of “normalising” interest rates.

The key issue is how the monetary policy committee evaluates the risk to the currency

The last hike, in July, took the repo rate up by just 25 basis points. Since then, official figures have shown that the economy contracted in the second quarter, which helped to persuade the committee at its last policy meeting in September to keep rates steady.

Nonetheless, not all analysts believe that a rate hike this week is a done deal.

“I don’t think it’s a given — I think it’s going to be a very difficult decision,” said Investec Asset Management strategist Nazmeera Moola. “The key issue is how they evaluate the risk to the currency — the main reason to hike rates now would be to take out some insurance by doing it ahead of the Fed.”

However, lower-than-expected oil prices were helping to keep a lid on inflation, and that, together with the poor outlook for economic growth, could persuade the committee to stand its ground, she said.

In September, the committee said its research showed that the outlook for inflation had improved slightly, although it was still set to breach its 3% to 6% official target range in the first and final quarters of next year.

Those forecasts could deteriorate as South Africa’s worst drought in many years means the country has to import maize, which will put upward pressure on inflation, as well as hit economic output.

“So far the impact of the weaker currency on inflation has been rather muted, but this is not to say this will always be the case,” said Nedbank economist Busisiwe Radebe. “If the MPC does raise rates this week it will be more a symbolic move . . . the bank will want to be seen as taking its inflation-targeting mandate seriously.”