Reserve Bank keeps interest rates steady

In attempting to find the balance between keeping inflation under control but not unduly undermining short-term growth, the South African Reserve Bank has decided to keep interest rates steady.

This is according to Reserve Bank governor Lesetja Kganyago, who announced that the repo rate would remain on hold at 6%, for now. The repo rate – or repurchase rate – is the rate at which the central bank lends to commercial banks. As a result the prime will remain at 9.5%.

Given that gross domestic product (GDP) was shown to retract by 1.3% in the second quarter of the year – with the risk of more negative data to come out of the third quarter – it was widely expected that the Reserve Bank would choose to hold rates. 

Inflation data released on Wednesday showed headline inflation had lowered to 4.6% on the year for August compared with 5% in July. This beat market expectations of 4.7%. Core inflation measured 5.3%, down from 5.4% in July. 

Kganyago on Wednesday reaffirmed the bank’s commitment to the rate-hiking cycle – to reach a normalisation of what had been historically low rates – which resumed in January 2014. 

The hold is a welcome respite as concerns abounded that a rate hike would be the contributing factor that would tip South Africa into a technical recession – that is, two quarters of negative economic growth.

The Reserve Bank’s monetary policy committee (MPC) is mandated to target inflation through rates decisions with an aim to keep largely inflation within the Bank’s target band of between 3% and 6%.

“The combination of sharply slowing growth and rising inflation compounds the dilemma facing monetary policy,” said Kganyago.

The domestic economic outlook has deteriorated following the surprise contraction of 1.3% in the second quarter of the year. And the rand experienced a further significant depreciation in response to domestic and global developments.

Although the rand has been one of the more volatile currencies, its trend depreciation over the year has not been significantly different to those of other commodity currencies and a number of other peer emerging economies, Kganyago said. 

However, the rand exchange rate remains an upside risk to the inflation outlook. “As noted in previous statements, a key uncertainty for the MPC is the extent to which the US policy normalisation is already priced into the currency. The fact that the rand appreciated in response to the Fed decision suggests that some depreciation is likely when US rates are increased. However, the extent is uncertain, with the possibility of a temporary overshoot in a highly volatile environment.”

Kganyago said that food prices remained of concern as a drought is expected to feed through into consumer prices in coming months. “Domestic food price inflation at the consumer level appears to have reached a low point of 4.3%, increasing marginally to 4.4% in July and August,” he said. “The pressures are expected to come from the drought-induced increases in agricultural price inflation for cereals and crops, which increased at a year-on-year rate of 38.7% in July.”

Globally, the slowing Chinese economy poses significant risks to the world’s economic outlook.

While to date the actual slowdown in China has been relatively moderate, a hard landing could have a severe impact on global markets, and on commodity prices in particular, he said.

“These risks, in conjunction with continued capital outflows from emerging markets, have resulted in heightened global financial market volatility and contributed to the decision by the US Fed to maintain its current monetary policy stance,” Kganyago said. “This delay has added uncertainty to an already volatile global setting.”

Some economists expect a 25% basis points rate hike to transpire from the bank’s November MPC meeting. But Investec chief economist Annabel Bishop says rates should in fact be moving in the opposite direction.

“The trend amongst the key commodity [currency] countries has been to ease monetary policy as the sharp, prolonged downturn in the commodity cycle weakened their GDP growth. Australia, New Zealand, Canada, Russia, Chile and Norway have cut interest rates significantly to support growth,” Bishop said in a note. “However, South Africa has hiked interest rates by 1.00% in its current upwards interest rate cycle, with 25 basis points this year to date, and a hawkish [favouring high interest rates to target inflation]  tone.”

Higher interest rates have not stopped rand depreciation, instead spurring some foreign sales of equities, as economic growth prospects dim as interest rates rise, Bishop said. “South Africa needs to ease monetary policy in line with other commodity countries to support economic growth, not raise interest rates.”

Kganyago said that one needed to bear in mind the effects of monetary policy come with a lag – in the banks view this is between 18 and 24 months. “Time will tell how the hike plays itself out,” he said.

He added that the decision to hike rates in July this year was the correct decision, just as all the monetary policy decisions are. “Every decision we have taken is underpinned by very rigorous analysis of the state of the South African economy … and the outlook for the South African economy … We have no doubt that the decisions we have taken are in the best interest of the South African economy.”

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