Reserve Bank in a quandary over rising recession risk

The risk of a recession in South Africa this year is mounting, making policy decisions more difficult for a Reserve Bank battling to balance the need to contain inflation and support a stuttering economy.

The likelihood of Africa’s most-industrialised economy contracting for two successive quarters in 2016 is 45%, according to the median estimate of nine economists surveyed by Bloomberg this month. That’s up from a 25% probability in December. Four of the analysts predict a recession this year. The International Monetary Fund has slashed its forecast for South African expansion by almost half to 0.7%.

“The environment has just deteriorated,” said Isaac Matshego, an economist at Nedbank, which puts the odds of a recession at 70%. “Commodity prices have dropped further; the rand has come under significant downward pressure. That will definitely have a negative impact on economic growth. We are looking for a number around 0.2% for this year.”

The rand has slumped 30% against the dollar since the start of last year, buffeted by the commodities rout, power shortages and the decision by President Jacob Zuma in December to fire the widely respected Nhlanhla Nene as finance minister that also sent bond yields soaring. Policymakers must weigh up how best to contain the resultant price pressures and keep inflation close to its 3% to 6% target band, without choking growth amid the worst drought on record.

The bank will “act with resolve” if inflationary pressures from the weaker rand spread more broadly in the economy, Reserve Bank governor Lesetja Kganyago said in an interview with Bloomberg TV in Davos last week. He also said 25 basis points wouldn’t be a “small” adjustment. Inflation climbed to a one-year high of 5.2% in December.

Forward-rate agreements, used to speculate on interest rate moves, are pricing in 30 basis points of rate increases on Thursday, while contracts starting in 12 months’ time predict the benchmark rate will be 1.57 percentage points higher in that period. The rand gained 0.3% to 16.3781 per dollar by Thursday morning South African time, while the yield on the 2026 bond fell two basis points to 9.59%. Kganyago is due to announce the monetary policy committee’s latest decision at 3pm in Pretoria.

All but two of the 26 economists surveyed by Bloomberg predict the central bank will raise the benchmark rate from 6.25%, with the majority anticipating more than the 25 basis-point adjustments made twice in 2015, even as economic growth prospects dim.

While the Reserve Bank’s mandate requires it to target inflation, it must also consider the impact monetary policy has on growth and unemployment; the latter stands at more than 25%. The extent of the rand’s decline may force Kganyago’s hand, at the expense of growth, according to Elize Kruger, an economist at Kadd Capital, a firm that sees a 45% probability of recession.

“I now expect the Reserve Bank to hike rates quite aggressively,” she said. “That will kill more growth. The chances of a recession are now bigger than they were at the end of last year.” – Bloomberg

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