The Reserve Bank’s Monetary Policy Committee (MPC) cranked up the benchmark repo rate by 75 basis points to 6.25% on Thursday to rein in consumer inflation which, prior to August, appeared to be hurtling towards 8%.

Three MPC members preferred a 75bp increase, while two preferred a 100bp rise.

Weighing the threat of higher inflation brought on by higher energy costs against the corrosive effects of load shedding on economic growth, the MPC opted to prioritise the inflation threat.

Highlights:

Sarb sees SA’s GDP growing by 1.9% in 2022 (from 2% before), 0.4% in Q3 and 0.3% in Q4; 1.4 in 2023 and 1.7% in 2024, above previous estimations.
With oil prices currently at around US$91 per barrel – Sarb sees them averaging $105 for 2022; $92 in 2023 and $85 in 2024.
The easing of global oil prices has contributed to a less aggressive rise in fuel price inflation for this year, at 33.7% (down from 38.8%). Further moderation in fuel price inflation is expected in 2023, averaging 1.7% (down from 5.7%).
Local food price inflation is seen averaging 8.1% in 2022 (up from 7.4%); 5.6% in 2023; and 4.2% in 2024.
Core inflation is seen averaging 4.3% for 2022 (unchanged); 5.4% (down from 5.6%) in 2023; and 4.8% (down from 4.9%) in 2024.
Headline inflation is seen averaging 6.5% in 2022 (unchanged); 5.3% (down from 5.7%) in 2023; and 4.6% in 2024.
The rand depreciated by about 3% against the US dollar since the July MPC meeting.
Rationale

Inflation hit a 13-year high of 7.8% in July before easing to 7.6% in August. That modest reduction did little to mollify the MPC, which opted for an aggressive jump in the repo rate to bring consumer inflation within its 3% to 6% target range.

The graph below explains the problem the MPC must solve. Consumer inflation (the blue line) breached the upper target range of 6% in the second quarter of 2022, and is likely to remain outside the range until the middle of 2023, when food and fuel inflation is expected to moderate. The primary tool used to cool inflation is the repo rate (in green), and it’s been a losing battle as consumer price increases veered dangerously close to 8%.

Inflation vs repo rate

The latest increase in the repo rate follows another 75-basis point increase in July, which took the rate to 5.5%, when energy prices shot up in response to the war in Ukraine, while local electricity and other administered price increases were perceived to present short- to medium-term risks.

In a note to clients this week, Capital Economics warned that the recent re-intensification of load shedding and soaring cost of living will weigh on the economy over the coming months.

“…austerity is likely to remain order of the day, further adding to headwinds facing domestic demand. At the same time, external tailwinds will probably fade as the global economy slows. Our forecast for GDP to expand by just 1.8% in 2022 is below the consensus.”

Also weighing on the MPC’s decision was the trajectory of the rand, which traded at R17.60 on Thursday, and appeared poised to challenge its all-time low around R19 to the US dollar, a level reached in May 2020.

Rand vs US dollar

The increase in rates is expected to cause pain across the economy.

The prime lending rate is likely to bump from 9% to 9.75%, with mortgage and credit rates squeezing already-beleaguered consumers. That should start to throttle demand for credit, which has already shown signs of plateauing over the last three months, according to Reserve Bank data.

The latest increase in interest rates returns SA to pre-Covid levels, but this time with galloping inflation and countrywide load shedding. Inflation bottomed at 2.1% in June 2020 due to the sharp decline in oil prices and lowering of interest rates to 3.5%, its lowest in decades.

Comments

Jacques Celliers, FNB CEO, says, “We are witnessing a concerted effort by the South African Reserve Bank and numerous other central banks around the world to mitigate the effects of higher inflation.

“The recent FNB/BER Consumer Confidence Index revealed a slight increase in consumer confidence in South Africa, and consumers have also experienced some relief due to decreases in fuel prices. However, South Africa must act swiftly to address issues such as the intermittent power supply, which continues to derail the country’s economic growth prospects,” he adds.

Mamello Matikinca-Ngwenya, FNB Chief Economist, says, “We expect the Reserve Bank to increase the repo rate by 50bps at the November MPC meeting, pushing it to 6.75%, the level where we think the policy rate will peak before falling in early 2024.”

EY Africa chief economist Angelika Goliger says although inflation has come off the boil slightly, dropping to 7.6% in August, it remains high. “It will likely be elevated for some time as firms try to make up in margins, and recover the difference between consumer and producer prices (which reached 18.0% in July). The depreciation in the rand over the past few days was more about a move towards the dollar than shedding the rand per se. However, a weaker currency adds to the likelihood of inflation remaining stubbornly higher with the cost of imports rising.

“The Sarb, along with the rest of the world, will be watching the US Fed closely, whose most recent dot plot shows aggressive tightening for the remainder of the year, pricing in 125 bps increase by December 2022. So we can expect further rate increases at the last two MPC meetings for the year, perhaps at a similar pace of the US Fed, if inflation does not cool markedly. This will add further pressure on consumers in the near term while it takes time for the higher interest rates to temper inflation.”

Terence Hove, senior analyst at Exness, says higher interest rates will likely contribute to lower valuations for stocks. “Hence the increased interest rates tend not to favour stocks in general. However, if the interest rate increase reduces the spread, or risk factor, for emerging market bonds, we could see a rally in bonds and the rand, which is essentially a play on interest rate differentials.”