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Brace for an October rate hike

27 September 2007 Gareth Stokes

If you were among the thousands of South Africans hoping that the August interest rate hike heralded the end of the rising interest rate cycle, then your hopes may soon be shattered. Latest inflation data suggests Reserve Bank Governor Tito Mboweni may have to hike rates again when the Monetary Policy Committee meets in October.

August CPIX figures show a year-on-year increase of 6.5%. This is a moderate improvement on Julys 6.7% but still too high to prevent further central bank action. Economists warn that "it is very likely to mean we are going to get an interest rate hike in October." Market commentators believe this hike is "not likely to affect the markets on the equities and rand side, but will have a negative impact on bond yields."

Although the domestic economy is showing signs of cooling and consumer behaviour appears to be moderating, these slowdowns do not support that the central bank has done enough in bringing CPIX back into its 3% to 6% target.

Key drivers are beyond government control

The key drivers of price inflation in South Africa are beyond government's control. The US dollar price of Brent crude oil determines domestic fuel prices while supply and demand on international financial markets determines the value of the rand against a basket of foreign currencies. Improvements in the rand to dollar exchange rate bring little relief because the dollar price of oil is on an unrelenting upward march. And the resulting higher price of domestic fuel mercilessly chases up the price of producing and distributing local goods.

Consumers are effectively punished on both sides of the equation. Not only do they directly suffer the rampant food prices; but their disposable income takes a hit each time interest rates are hiked too.

The above scenario has prompted many to raise questions about the use of interest rates in central bank inflation targeting. Why should the central bank continually hike rates if these actions have no impact on key inflation drivers? Some suggest the bank is unnecessarily putting the brakes on domestic growth while inflation remains unchecked.

No end in sight

"Have we started to see a peak in inflation and was the peak last month?" asks Investment Solutions economist, Chris Hart. Hart believes that slower global economic growth and signs from domestic consumers are promising; but may come too late to halt the inevitable.

There are only a handful of economists who are willing to predict an unchanged interest rate in October. Annabel Bishop, economist at Investec Group believes that "CPIX inflation is still likely to only fall back within the inflation target range in 2008." She touches on consumer behaviour to suggest we might not see a hike in October. "Given recent evidence of slowing consumer demand and credit usage, we continue to believe the SARB will leave interest rates unchanged at the October MPC meeting."

The majority are confident we will see another 50 basis point rise.

Time to move the target

Perhaps it is time for the central bank to consider a slight change to its inflation targeting policy. It is possible that global market conditions differ from those prevailing when the target range was initially set. A shift in the band to rather target a 4% to 7%, or even a 4.5% to 7.5% range may be appropriate given current predictions for global economic GDP growth.

GDP growth definitely contributes to inflationary pressures in the domestic economy. Government's huge infrastructure projects have resulted in significant price pressures in all spheres of the building and construction industries. And this economic growth is boosting the number of citizens in full time employment, injecting more disposable income into the economy and driving prices higher.

We should not lose sight of the fact that one of South Africa's largest trading partners (China) is growing at a rate of 9% per annum. Inflation pressures will increase as the percentage of export trade with similar high growth partners increases. The impact of GDP growth in China, India, Russia and Brazil can already be seen in the soaring prices of resources like iron ore, copper, platinum and other base and precious metals.

A change to central bank thinking on inflation targeting and CPIX ranges is unlikely to happen overnight. We suggest consumers brace themselves for another 50 basis point hike in October.

Editor's thoughts:
Domestic consumers have been hard hit by a series of interest rate hikes over the last twelve months. With many new home owners struggling with million-rand-plus mortgages we have to wonder how many more blows they can absorb. Do you think there is a strong case for the Reserve Bank to modify its stance on using interest rates for inflation targeting? Send your comments to




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