Strengthening rand may not stave off interest rate hike

THE Reserve Bank’s monetary policy committee will walk a tightrope when it meets this month. News this week from the US improved the chances that South Africa’s interest rates could be kept on hold, but concerns over rising inflation could force the bank’s hand.

The chances of interest rates remaining unchanged, at least for a bit longer, improved when the US Federal Open Market Committee implied on Wednesday that US rate hikes will be gradual — resulting in the weakening of the dollar and support for emerging market currencies such as the rand. A firmer rand, in turn, improves the inflation outlook and supports unchanged rates rather than further policy tightening.

The rand strengthened from R14.61 to the dollar to R14.39 following Federal Reserve chairwoman Janet Yellen’s announcement.

The Federal Reserve committee said US economic conditions will “evolve in a manner that will warrant only gradual increase in the federal funds rate”. The committee’s next decision would depend on data about the performance of the US labour market and inflation.

FNB economist Mamello Matikinca said there was potential for further rate hikes of 50 basis points this year. The Reserve Bank would face the challenge of balancing weak growth and rising prices, she said, but “upside risks to the inflation outlook will take precedence”.

“At its last rate announcement the MPC noted that it expects inflation to peak at 7.3% in the final quarter of the year; we, therefore, believe the Reserve Bank will gradually hike into this peak,” said Matikinca.

The latest inflation numbers and the improved rand exchange rate suggested that the peak in inflation would be slightly lower than anticipated.

“But headline inflation is expected to remain above the upper end of the Reserve Bank’s target band for a prolonged period,” she said.

Rates in South Africa have been hiked at each of the past three monetary policy committee meetings — 100 basis points since November last year — as the outlook for inflation has continued to breach the 3% to 6% target band.

This week S&P Global Ratings (formerly Standard & Poor’s) said South African banks faced growing credit risks as the economy worsened. Concerns were rising interest rates, which affected the ability of customers to service their debt, and inflationary pressures on the banking system’s asset quality. The agency forecast a 75 to 125 basispoint rise in interest rates over the next 12 to 18 months and said inflation would erode disposable incomes.

Jean-Michel Six, MD of S&P Global Ratings and the agency’s chief economist for Europe, Middle East and Africa, expected the Federal Reserve to raise its policy rates twice this year, with the next rate hike possibly coming as early as next month.

“The excess slack in the labour market continues to diminish, thus paving the way for the Fed to ever-so-slowly start to wind back its very accommodative monetary policy stance,” he said. Inflation in the US had started to move up recently with the low base effect from last year’s fall in oil prices now wearing off.

“The impact on the rand [of the next US rate hike] is likely to be modest because markets have broadly anticipated the Fed’s next moves and have factored in a gradual, mild tightening of US monetary policy,” said Six.

The trajectory in the rand mirrors the basket of emerging market currencies that have strengthened on the back of rising commodity prices and the renewed dovish comments from the Federal Reserve.

Investec chief economist Annabel Bishop said commodity prices had risen from a low in

Upside risks to the inflation outlook will take precedence

November last year, lifting particularly in March and April, which had helped strengthen the rand because South Africa was a substantial commodity exporter.

But not everyone is convinced that rates may be held.

Peter Worthington, Barclays Africa senior economist, forecast a 25 basis-point hike this month, due in part to higher than expected increases in food prices and the first evidence that currency weakness was affecting domestic prices.

But he added, “the risks of a pause are rising”, even though forecasts of a multi-quarter breach of the inflation target remained.

Worthington said he anticipated another two interest rate hikes of 25 basis points each — in September and in January 2017 — with headline CPI inflation declining to within the Reserve Bank’s target range from the second half of next year.

“We think there may be room for a 25 basis-point cut in November 2017,” he said.