Rates hike boosts confidence, growth
There was no surprise when last month’s inflation remained outside the South African Reserve Bank’s target band for the third month in a row. But the bank’s decision to hike rates by 0.25% was enough to boost investor confidence and rally the local currency bond market.
Consumer price inflation came in at 6.6% for June, as reported by Statistics South Africa on June 23 – unchanged from the corresponding annual inflation rate for May.
Inflation had burst out of the bank’s target band of between 3% and 6% in February, and has remained high since. It is expected to average at 6.3% this year, according to the bank’s governor, Gill Marcus, in her monetary policy committee announcement on July 17. She also said the bank had revised its growth forecast for the year down to 1.7%, from 2.1%.
In a move to assure South Africans that the central bank would not allow inflation to run away, the committee decided to hike rates by just 25 basis points. This would ensure that there wouldn’t be too much strain on the economy.
The move may have surprised some economists, but it appeared to please investors. It caused rand bonds to rally after inflation proved high again last month, and economic growth forecasts continue to be revised downward.
According to financial software, data and media company Bloomberg, Wednesday marked the biggest rally for local currency bonds since March and this signalled growing investor confidence in Marcus’s efforts to tackle inflation without choking economic growth.
Bloomberg said global funds have bought a net $515-million of South African bonds this month, extending inflows this year to $1.8-billion, according to data from the Johannesburg stock exchange.
It noted that South Africa was one of the emerging markets that benefited from the Ukraine crisis, which caused investors to move funds out of Russia into other high-yielding markets.
Meanwhile, the rand has strengthened by 2.4% since the Reserve Bank raised the repo rate.
Henk Langenhoven, chief economist at the Steel and Engineering Industries Federation of South Africa, said that fiscal policy was either contributing to inflation or was, at worst, neutral in containing it, and monetary policy was clearly trying to hold the fort. He said, in a press statement, that the inflation numbers were a confirmation of the Reserve Bank’s motivation to increase interest rates.
The conflicting signals for the optimum policy response – low economic growth, rising inflation, a potential fiscal deficit as well as the precarious shortfall on the balance of payments – were not making the options any easier.
“[Last month’s] figure of 6.6% is high, and may fuel expectations of more to come. This is the key problem facing Marcus: managing inflationary expectations with interest rate increases without stunting domestic growth, while keeping an eye on what other central banks are doing,” the economist said.
“She is, in a sense, trying to engineer a soft takeoff of growth, rather than a soft landing.”