Warning over ‘second-round’ threats to inflation in South Africa – with more rate hikes on the way

 ·22 Jul 2022

The South African Reserve Bank’s Monetary Policy Committee (MPC) surprised financial markets by delivering its biggest increase in borrowing costs in almost two decades and signalled a faster pace of hikes through next year.

A combination of runaway inflation, tightening policy cycle by major global central banks, and uncertainty over the Russia-Ukraine war with its ramifications for commodity prices and economic growth forced the SARB’s hand, said FNB.

The monetary policy committee raised the repurchase interest rate to 5.5% from 4.75%, Governor Lesetja Kganyago said Thursday in an online briefing. It’s the biggest hike since September 2002 and aligns the SARB with other global central banks unleashing the most aggressive tightening of monetary policy in a generation to cool surging inflation, Bloomberg reported.

The implied policy rate path of the bank’s quarterly projection model, which the MPC uses as a guide, now indicates its key rate will be at 5.61% by year-end, compared with its May forecast of 5.3%. It’s seen at 6.45% by the end of 2023, up from 6.21%.

“The bank is clearly becoming more concerned over second-round threats to the inflation outlook, revising too its core CPI estimates next year by 0.5pp to 5.6% average,” said Jeff Schultz, senior economist at BNP Paribas South Africa.

Nominal wage growth creeping up towards 6.0% this year and above 7% in 2023 by the SARB’s latest estimates we believe has made it more sensitive to the balance of risks to the inflation outlook which it unequivocally states are to the ‘upside’, he said.

“Bottom line: We view the SARB’s rhetoric as increasingly hawkish, and correctly so we think, given much stickier CPI projections and upside risks building through wages and unit labour costs.

“Its communication was crystal clear that it is primarily concerned with nipping inflation and inflation expectations in the bud and ‘is determined’ to do ‘what is necessary’ to achieve its end goal, regardless of structural deficiencies in the economy (load shedding) and risks to global economic growth and activity.”

100 basis point increase

The decision was split among the MPC members with three members preferring the 75 basis point increase, one motivating that a 50 basis point increase would be more appropriate and one wanting a 100 basis point increase. Even though the 75 basis point increase was larger than expected, interest rates are still at low levels compared to history, said Luigi Marinus, portfolio manager at PPS Investments.

The vote split suggests the central bank will maintain its hawkish bias in September “meaning we can already narrow down the range of options to 50 basis points or 75 basis points, leaving 25 basis points and 100 basis points as tail risks in case data comes in particularly weak or strong, respectively,” said Cristian Maggio, head of portfolio strategy at TD Securities in London.

Sanisha Packirisamy, an economist at Momentum Investments, said the SARB is likely to maintain a hawkish tone as it responds to rising local inflation, persistent upside risks to the inflation trajectory, a more rapid pace of interest rate normalisation, globally, and a marked deterioration in longer-dated inflation expectations.

“As such, we have revised our interest rate view and now expect the SARB to follow with a 75-basis point hike at the September meeting and a 50-basis point hike at the November meeting. Additional interest rate hikes will be dependent on whether the peak in inflation is indeed reached by September/October as current market forecasts suggest.”

Another 75-basis point hike remains the base case for September for NP Paribas South Africa, “but its latest communication, we believe, clearly opens the door for a larger 100bp hike at its next scheduled meeting should CPI continue to surprise to the upside,” said Schultz.

“We don’t necessarily think that this changes our call for a 7.00% terminal rate, but rather the timing which could conceivably now be achieved by year-end vs our still well above consensus January 2023 forecast.”

Policymakers are acting with urgency to avoid losing their grip on inflation expectations, which the central bank prefers to anchor close to the 4.5% midpoint of its target range. South Africa’s annual inflation rate reached 7.4% in June, the highest level since the global financial crisis.

“Our assessment now is that this inflation risk is no longer transitory, but that there is persistence that is emerging,” Kganyago said. “But that doesn’t mean that inflation is permanent. If the persistence is rising in inflation, you can rest assured the South African Reserve Bank will act, with scale, timeously, to protect the income of South Africans.”

Reserve Bank modelling shows a significant acceleration in headline and core inflation, both of which will only return to close to the target midpoint in the fourth quarter of 2024. Though the outlook may deteriorate further, with power-utility Eskom 7% wage increase possibly setting a precedent for other pay negotiations, said Bloomberg.

The MPC would be concerned about economy-wide wage settlements that are consistently above inflation expectations as that may prompt a wage spiral, Kganyago said. “Once you have a wage-price spiral, it is going to take even more drastic policy measures from a monetary policy perspective to deal with inflation and we shouldn’t be there,” he said.

Narrowing the spread

The central bank’s preemptive hiking cycle started in November and Thursday’s move helps to narrow the spread between inflation and the benchmark rate, potentially burnishing the appeal of local assets to offshore investors and supporting a currency that’s weakened by more than 6% against the dollar this year.

The higher cost of money adds to the burden of households facing a cost-of-living crisis spurred by rising food and fuel costs, and threatens to weigh on household consumption which accounts for about two-thirds of gross domestic product, said Bloomberg.

While the move to lift borrowing costs is painful for now, it’s “a sign of a central bank acting credibly to return the inflation rate to their target in order to mitigate the pain of higher inflation down the line,” said Angelika Goliger, chief economist at EY Africa.

The central bank predicts the economy will contract in the second quarter due to flood damage in the province that’s the second-biggest contributor to GDP and deeper, more frequent power outages.

Still, it raised its GDP forecast for 2022 to 2% from 1.7%. The slowdown in the economies of key trading partners, including China, and fears of a global recession are risks to the outlook, Kganyago said.

The SARB has reduced its forecast for global growth in 2022, 2023 and 2024, while the forecast for SA GDP growth increased from 1.7% to 2.0% in 2022, but decreased to 1.3% and 1.5% in 2023 and 2024 respectively, from the 1.9% forecast in both years in the previous meeting.

  • Reporting with Bloomberg

Read: Reserve Bank shocks with 75 basis point rate hike

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