Interest rates may be on hold for now
The rate hike and currency weakness in January saw both the markets and economists calling for an aggressive series of rate hikes. At this time, the forward interest rate market was pricing in six rates hikes over the next 2 years.
The currency weakness up until January will no doubt produce higher inflation numbers in the months to come. The 6% upper limit target is widely expected to be breached when CPI is announced on Wednesday this week and this is a concern for the SARB. However, counter-balancing this, we have seen a very poor growth picture emerge over the last few months and the rand has recovered from its weakest point of 11.28 to the dollar, back to 10.35 where it was at the end of last year.
The MPC reacted to pressure in January when there was significant selling of our currency as concerns over the so-called fragile 5 dominated. The central banks of Turkey, Brazil and South Africa all reacted to this wave of selling by raising interest rates to shore up their currencies. The root cause of these sell-offs is that these countries rely on foreign portfolio flows to fund their current account deficits. This necessitates that interest rates are kept at higher levels than investor’s home markets (e.g. the US).
The continued improvement of the US economy has meant that, although the timing is unclear, there is growing pressure to start normalising interest rates which will make the yields available in markets such as SA less attractive.
We do think that we are in a rate hiking cycle but the pressure to raise rates is coming from the recovery of the developed world and this is likely to continue to be a slow process. The MPC has a tough job balancing domestic economic weakness and potential exogenous shocks caused by policy makers in the US. Since the last MPC meeting we have seen the leading indicator measure fall below 100 which indicates contraction, the PMI came out below 50 also indicating weakness in manufacturing. Aggressive rate hikes will produce further weakness in an already fragile economy and hurt the heavily indebted consumer, while further significant currency weakness will produce uncomfortably high levels of inflation.
On balance, the MPC is likely to stay on hold this week and react with higher rates to currency weakness produced by portfolio outflows as and when these episodes occur.
