British High Commission Pretoria/Cape Town
In a proactive move the Reserve Bank hikes rates for the first time in 18 months. A weak Rand, threatening imported inflation, mainly to blame. External conditions for the economy will be key to its health.
On 29 January, the Reserve Bank announced a surprise increase to interest rates by 50 basis points, to 5.5%. This represented the first change to interest rates in 18 months, during which time they had been at an historic low. Prior to the announcement, the consensus among economists had been that a rate increase would eventually come, but not this early.
Why the hike?
In its public explanation, the Monetary Policy Committee (MPC) revealed it had revised it inflation forecasts for 2014 to much higher levels than before. Despite lower than expected inflation numbers earlier in the month and a lack of evidence of domestic demand pressures, it now expects CPI to average 6.3% (peaking at 6.6%) in 2014 rather than the 5.7% forecast in November. This would breach the 3-6% target band.
The chief driver was the weak Rand. On 27 January, the Rand had fallen to a five year low of R11.25 against the dollar, caused by the problems in other emerging markets and investor uncertainties around the platinum strikes. Whilst avowedly reluctant to directly target the exchange rate, the MPC became concerned by the growing risk of imported inflation.
The MPC is also said to believe the global crisis had moved decisively into an exit phase, which would impact on emerging market currencies and capital flows. Some analysts suggest this hike is the first step in a plan to normalise real interest rates.
The decision also firmly anchors inflation expectations and boosts the Reserve Bank’s credibility as an orthodox, independent central bank. Since the MPC changed its inflation targeting mandate to become more growth friendly (during the 2008 financial crisis), markets had been unsure how far growth needs would be prioritised over inflation.
More to come?
Most economists believe this is the start of a tightening cycle with another hike due to come in the second half of 2014. However, the pace and depth of this will be influenced by Rand movements, capital flows and domestic conditions. Immediately after the announcement the exchange rate against the dollar weakened and remains there.
The Reserve Bank simultaneously cut its 2014 growth forecast from 3% to 2.8% but there are mixed assessments over how much pain this will cause the economy. Most analysts believe the consumer and banking sectors are strong enough to withstand the hike for now. But the economy is vulnerable, running twin fiscal and current account deficits and facing mining strikes, high unemployment and rising consumer debt levels (two thirds of indebted consumers are already struggling to service their debt).
External conditions – demand for SA’s exports and global investor preferences – will remain crucial as to how well the economy performs.
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