Brace for interest rate hike, warn economists

All eyes will be on the South African Reserve Bank’s (Sarb’s) monetary policy committee (MPC) when it announces the first interest rate decision of the year on Thursday. The general consensus among economists is that the outcome will be a 50 basis-point hike.

“We forecast a larger incremental 50bp (basis-point) rate hike this time, given both an extended breach of the 6% target ceiling in our CPI (consumer price index) outlook and heightened inflation risks (in rands and food prices mostly),” said Citi Research on Monday.

“No matter which path Sarb chooses, we see a total 100bp (basis point) in rate hikes in 2016. To do a 50bp hike now makes sense to us for it gives the MPC more options in March (pause, +25bp or +50bp) which keeps it ahead of the curve.”

Rand Merchant Bank (RMB) economist John Cairns believes the MPC faces a choice of a 25bp or 50bp hike. “We favour the former, expecting them to stick to the measured pace of normalisation, but with a hawkish statement.”

This is because a 50bp interest rate increase would shore up confidence levels in both the Reserve Bank and the rand, “flattening the interest rate curve”, according to Cairns.

“The rand, admittedly, is usually not very sensitive to rate changes but we should expect an outsized move, either way, given the negative sentiment in the market over the past two months,” said Cairns.

However, RMB’s Deon Kohlmeyer has a different view: “… the market is still seeing a 50bp hike by Sarb as the most likely outcome despite some of the governor’s comments in Davos which some participants have regarded as perhaps indicating only 25 basis points. We believe Sarb will continue in a measured fashion and will stick to 25 points this week,” he said on Monday.

In his preview of the MPC’s meeting, Nomura emerging markets economist Peter Attard Montalto said the Reserve Bank “has been careful in its rhetoric” ahead of the MPC meeting. “On the one hand it wants to show it remains resolute and credible and will hike in response to a shifted outlook, but on the other hand it also wants to contain market perceptions of a large panicked hike.”

He believes the Reserve Bank knows it is into a new rand paradigm after finance minister Nhlanhla Nene’s firing in December, which probably in theory means that higher real rates are necessary as the country’s credit risk rises. Montalto is of the view that a 50bp hike “can be sold as an adjustment to this new environment” while not being a move to support the rand.

“Indeed, Sarb is eager to show to markets that it is not looking to backstop the ZAR or target levels and so is keen to limit expectations of 75bp or 100bp increases, even if these might be backed by some MPC members,” said Montalto.

He pointed out that food price moves and the rand pose real challenges to the inflation forecast, and now envisages average inflation of 6.5% in 2016 and 6.7% in 2017. Montalto believes the new forecast will lead to inflation being outside the Reserve Bank’s target in the third and fourth quarters. It will revert in the first quarter of 2017, “which would be far too bullish (low) vs our own forecast and would signal an underestimate of the long and lagged impact of higher food prices and the weaker ZAR”.

Said Montalto: “A 75bp or 100bp hike would be a pleasant surprise, but carrying only a 25% probability. We think a 25bp hike would be a policy mistake and would signal it is too worried about growth over inflation and too happy to be behind the curve with serious inflationary pressures building up.

“We assign a 15% probability to a 25bp hike. We attach a 0% likelihood to rates unchanged and therefore a 60% probability to a 50bp hike. We continue to expect rates to enter tight territory of 8.50% by end-Q1 2017 (8.00% end-2016), because of our inflation forecast and the implications that has for expectations and wages.” – Fin24

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