Reserve Bank will stay tough, even as inflation softens

Despite all indications that high inflation — which has clawed at the pockets of consumers for well over a year now — will start to lessen, we can’t count on interest rates following anytime soon.

This week, the South African Reserve Bank (Sarb) monetary policy committee (MPC) will meet to decide how big an interest rate hike consumers can endure, after inflation hit a 13-year high in July. Economists expect that inflation will have started to retreat from July’s 7.8% peak in August, as the month saw the first decline in the hefty petrol price since May.

However, with central banks around the world remaining hawkish, and inflation expectations driving wage demands higher, experts agree the Sarb is unlikely to let up, as it endeavours to restore the cost of borrowing to its pre-pandemic level. 

Hawks

In an example of how cooler inflation readings have done little to turn hawks to doves, last week the United States Bureau of Labour Statistics released data showing that consumer costs moderated to 8.3% year-on-year in August, compared to 8.5% the previous month. The fall in petrol prices stateside contributed to the softening of inflation.

But the seemingly benign data triggered a plunge in Wall Street shares — marking the worst selloff since the early months of the pandemic.

Behind the frenzy was the data’s indication that price hikes had become increasingly broad-based. There were large increases in the shelter, food and medical care indexes. The food index increased 11.4% over the last year, the largest 12-month increase since the period ending May 1979.

Now, traders are pricing in a steep 75 basis point or higher rate hike when the US Federal Reserve meets this week. They are also expecting the rates to remain above 4% next year. 

In 2019, the US interest rate was the highest it had been since the 2008 global financial crisis, at about 2%. It was slashed close to zero after the pandemic hit.

Currency 

Expectations of a 75 basis point hike stateside caused the rand to weaken to R17.51 to the dollar, from just over R17 the week prior. The domestic currency has not traded at that level since August 2020. The rand is expected to trade at 17.74 by the end of this quarter, according to Trading Economics global macro models and analysts’ expectations. Looking forward, Trading Economics estimates it to trade at 19.11 in 12 months’ time.

This week, the Sarb’s MPC will be weighing a 50 basis point hike against a more aggressive 75 basis point hike, with expectations by analysts largely skewed to the latter. All 17 economists polled by Bloomberg expect a 75 basis point hike.

A higher borrowing rate will put pressure on already strained South African consumers, weakening demand and hamstringing the country’s already sedate economic growth.

The rand’s weaker footing — which saw the domestic currency depreciate to close to R17.70 on Monday morning — will factor into the MPC’s decision. A feeble domestic currency signals higher inflation. 

Moreover, although lower crude prices saw the petrol price go down in August and September, a weak rand means the size of price cuts is much smaller than they would have been had the currency maintained some of the momentum we saw earlier in the year.

Spiral

Meanwhile, the International Monetary Fund said in a blog post last week the second-round effects of high energy costs, such as a wage price spiral, should prompt central bankers to “respond firmly”.

“To the extent that central banks remain adequately vigilant, current high inflation could still cause higher compensation for the cost of living than usual but need not morph into a sustained increase in inflation,” it said.

The reserve bank’s hawkish stance, which led the MPC to raise the repo rate by 75 basis points in July, has come off the back of higher inflation expectations, which have pushed up wage demands.

In July, after a wildcat strike, Eskom and labour unions agreed to a 7% wage increase. Earlier this month, workers in the clothing sector also secured a 7% increase — which, although below the current inflation reading, is still higher than the 6% ceiling of the  reserve bank’s target rand — suggesting inflation expectations have become unanchored.

Earlier in the month, Sarb deputy governor Rashad Cassim said it was critical for the MPC to avoid a wage spiral. 

“It is not the role of the MPC to dictate what wage earners should take home … But we do need to assess how broad labour income helps determine whether supply shocks, like the ones we are experiencing today, generate more inflation in the economy,” he said.

Hugo Pienaar, chief economist at the Bureau for Economic Research, said he expects headline inflation to remain high, coming in at 6.8% in December. “Inflation has likely peaked. But the point is that, over the next six months or so, it is likely to remain at levels that are very uncomfortable from the reserve bank’s point of view.”

Gina Schoeman, head of research at Citi, agreed — noting that although fuel prices are decreasing, food inflation has not yet peaked. Schoeman expects the reserve bank to dial back the scale of the rate hikes after September. 

“But they are still going to carry on hiking because they are concerned about inflation becoming too persistent.”

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