Interest rates hike ‘very likely’ despite weak economy

The Reserve Bank is very likely to raise interest rates at its next policy meeting in November, especially given a fresh bout of volatility in emerging markets that knocked the rand to a new record low on Thursday, threatening to worsen South Africa’s inflation outlook.

Although its monetary policy committee  left the key repo rate steady at 6% in a unanimous decision when its meeting ended on Wednesday, the bank’s governor, Lesetja Kganyago, made it very clear that it was alert to inflation risks and would not hesitate to raise interest rates if necessary, despite the weakness in the economy.

He pointed out that inflation was likely to rise above its 3% to 6% target range twice next year and although the breaches were expected to be temporary, the probability of a more extended one was “relatively high”.

The rand remained the main “upside” risk to inflation and was likely to react further to the anticipated start of monetary tightening in the US, which Federal Reserve chairwoman Janet Yellen said late on Thursday was still likely to happen before the end of the year, even though the Fed also left interest rates steady last week.

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Emerging markets were severely shaken in the run-up to her speech, which knocked the rand to a fresh record low of R14.08 against the dollar, in line with the movements in peer currencies. The currency was trading at R13.08 to the dollar on Friday morning.

“I think with the inflation cycle turning closer to the expected breach of the target, as an inflation-targeting central bank, the Reserve Bank will hike interest rates by 25 basis points in November,” said Razia Khan, research head for Africa at Standard Chartered.

“It won’t be able to ignore volatility in emerging markets, which will be front-loaded ahead of a Fed hike that  will probably happen in December.”

At a press conference after the monetary policy committee announcement,   Kganyago said   the bank did not move “in step” with the Fed, but had to watch what was happening in the rest of the world and gauge its impact on South Africa’s economy.

The Reserve Bank raised rates independently in July, he said.  The cumulative increase in domestic interest rates has been 75 basis points since the tightening cycle began in January last year, but South African monetary policy remained expansionary, he said.

Kganyago said the July interest rate hike, which the monetary policy committee had been divided on, was the correct decision, despite news since then that the economy contracted unexpectedly by 1.3% in the second quarter of this year.

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This was unlikely to happen again in the third quarter, but the growth outlook remained “relatively weak” in the face of declining business and consumer confidence, he said.

The bank slashed its July growth forecasts for South Africa by half a percentage point, predicting the economy would expand by just 1.5% this year, 1.6% next year and 2.1% in the subsequent two years. The estimates for the next three years are in line with the most negative predictions from independent economists.

The monetary policy committee highlighted other constraints to economic growth, including power shortages, weak consumer demand, declining growth in disposable income and volatility in global financial markets. But it concluded that the risks to the outlook were nonetheless “balanced”,  which surprised some economists.

In the conclusion of its statement, the committee chose to focus more intensely on the inflation outlook, where it said the risks were on the “upside” and could impact negatively on inflation expectations. Its inflation forecasts showed a “near-term improvement and a slight medium-term depreciation”.

Inflation was expected to average 4.7% in 2015 from 5% previously, 6.2% next year and 5.8% in 2017, the bank said. Some analysts think these estimates are too negative, given the deflationary global environment and lower oil prices.

Nonetheless, the prevailing view in South Africa suggests that domestic interest rates will go up soon. Nedbank said  the monetary policy committee was likely to hike in November ahead of a likely US “lift-off” in December. “We expect the main part of the hiking cycle to be in the first half of 2016 as the [committee] responds to rising inflation and interest rate normalisation in the US and UK,” it said.

According to Nedbank economist Busi Radebe, domestic money markets are giving the chances of a rate hike in November a 30% probability. But this was likely to increase in the run-up to the next Fed meeting on October 27 and 28, she said.