Further interest rate hikes necessary
Economic forecasters’ views on the interest rate decision at the upcoming Monetary Policy Committee (MPC) meeting, to be held on 17 July, have been quite mixed given the on-going stagflationary bind that the South African Reserve Bank (SARB) finds itself in.
Domestic growth prospects are weakening in the face of labour unrest in the steel and engineering sectors of the South African economy as workers belonging to the National Union of Metalworkers of South Africa (NUMSA) embark on their third week of an intensifying strike, further damaging business confidence and investment prospects. Although the MPC had downwardly revised their real GDP growth forecasts for 2014, from 2.6% to 2.1% at the previous meeting, on-going tensions in the labour market flags further downside risks to overall growth prospects this year.
Furthermore, while the trend in global growth has been shifting towards strengthening developed market economies, the trajectory for emerging economies has weakened somewhat, posing a further risk to the outlook for South African exports and thus overall GDP growth. While monetary policy actions have been mixed across emerging market countries, with a handful of emerging market central banks hiking rates where either inflation or extended double deficits have become a problem, developed markets are expected to maintain accommodative monetary policy in the absence of demand-pull inflationary pressures. Within the developed economies, however, monetary policy rhetoric has begun to diverge, with the likes of policy makers in the US and UK contemplating normalisation tools, while those in Japan and the Eurozone maintain an easing bias on the back of lingering growth and deflation concerns.
Monetary policy normalisation in the developed world poses a significant threat to emerging economies facing elevated current account deficits, such as South Africa, which remain heavily reliant on foreign financing. The South African Reserve Bank (SARB) has noted that, while real policy rates remain very accommodative in the context of developments in the real economy, this stance cannot be maintained indefinitely. The rand remains vulnerable in an environment where monetary policy normalisation is on the horizon for the world’s major central bank - the US Federal Reserve - given South Africa’s relatively low real short-term rates on an emerging market comparison and the need to attract foreign capital flows to cover South Africa’s wide current account deficit.
Given the SARB’s primary mandate of price stability, we expect that interest rates will be hiked at the upcoming meeting in light of further upside risks to the inflation outlook and sticky inflation expectations (as monitored by the Bureau of Economic Research), which remain anchored at the upper-end of the inflation target band. While a case for either no hike or a 25 basis point rise in short-term rates could be made, in light of current growth concerns, we are arguing for a 50 basis point rise on the back of further downside risks to the currency, upward pressure on administered prices and wage settlements negatively impacting the outlook for core inflation.
