In one of the most closely watched monetary policy committee decisions of the year, the South African Reserve Bank (Sarb) raised interest rates by 25 basis points, taking the repurchase rate to 6%.
The hike, the first this year, was a very close call and market analysts were divided about whether the Reserve Bank governor, Lesetja Kganyago, would announce a 25 basis point increase or keep rates unchanged.
The bank has given several warnings that it is on a path of interest rate increases in line with rising inflation risks and the “normalisation” of monetary policy.
Nevertheless, Kganyago stressed that against a backdrop of weak economic growth and declining consumer and business confidence, any future rate hikes by the bank would be “highly data dependent”.
In response to questions Kganyago highlighted that when weighing the risks to both inflation and growth, the committee had to be “highly cognisant” of “an environment where growth is actually fragile”.
Hence it deemed the gradual hike of 25 basis points “an appropriate step at this stage”.
Important concerns
The rand’s outlook, in the context of South Africa’s “twin” current account and budget deficits, recent declines in commodity prices and risks of food inflation were important concerns for the committee.
“The rand remains vulnerable to global market reaction to United States monetary policy normalisation, particularly in the context of South Africa’s twin deficits,” Kganyago said, adding that exchange rate pressure was exacerbated by the recent significant decline in commodity prices. This was expected to “impede” improvements to the current account position.
Further reaction to plans by the US to tighten its monetary policy was also a risk, he said, and “could cause inflation to diverge even further from target, and set in motion an exchange rate inflation spiral”.
The committee highlighted “upside risks” expected from food prices, which have yet to react to sharp increases in spot prices for agricultural commodities.
Although consumer price inflation for June had surprised the market by coming in weaker than expected, Kganyago said that this “respite is expected to be temporary”.
On Wednesday, headline inflation for June came in at 4.7%, versus market expectations of 5%. Core inflation – which excludes food, fuel, nonalcoholic beverages and energy – slowed to 5.5% from 5.7%.
But persistent “elevated levels” of inflation forecasts and ongoing risks to the inflation outlook “remained a concern”, Kganyago said.
The committee’s members voted four in favour of a rate hike with two voting to keep rates unchanged.
The move gave the Reserve Bank the space to keep any future rate increases more moderate, said Razia Khan, of Standard Chartered Bank. “By raising the repo rate … now, the Sarb monetary policy committee may well have averted the need for an even sharper, potentially more painful rise in interest rates further out”.
The rate announcement was made in a week in which commodities across the board plummeted dramatically.
This has come as the dollar has steadily strengthened on a gradually improving US economy, adding to the case for the US Federal Reserve to begin hiking interest rates.
The outlook for commodities is unlikely to improve this year, according to the World Bank. In its July 2015 Commodity Markets Outlook report it said it expected all main commodity price indices to decline this year because of “abundant supplies and, in the case of industrial commodities, weak demand.”
A number of central banks in commodities-reliant countries have opted to drop their rates in a bid to support their economies.
Slide in commodities
Bloomberg said New Zealand’s Reserve Bank joined its counterparts in Canada and Australia in responding to the slide in commodities. New Zealand cut its interest rates to 3% as inflation remained low and demand for its dairy exports declined.
It follows Canada’s central bank, which cut interest rates for a second time thanks to declining oil prices, and Australia’s Reserve Bank, which also cut rates twice in 2015 as its mining boom dwindled, said Bloomberg.
Unlike many other central banks, Sarb’s mandate requires it to focus mainly on price stability and curbing inflation, said Bart Stemmet, of NKC African Economics.
This has left it “between a rock and a hard place”, said Stemmet. “While we are in a slow growth environment and ideally some stimulus would help, because their main mandate is price stability, they’re in a bit of a difficult position [compared with] most other central banks who are looking to ease [policy rates] and help their economies somewhat,” he argued.
David Crosoer, research and investments executive at PPS Investments, said despite being one of the few central banks to raise rates recently, the local policy rate remains “abnormally low and the increases so far are measured, compared to previous cycles”.