Reserve Bank's next interest rate decision on a knife edge

The result of the Reserve Bank’s Monetary Policy Committee (MPC) meeting later this month is very much in the balance.

Jean-Pierre du Plessis, Fixed Interest Strategist at Prescient Investment Management commented that inflation is uncomfortably high at 6.6% and is expected to remain above the Reserve Bank’s target for the remainder of 2014.

“With a repo rate of 5.5% and a negative real rate of 1.1%, monetary policy is very accommodative, and on this basis alone the MPC could be expected to act.

“However the higher inflation we have seen has not been as a result of demand pressure. We had negative economic growth in the first quarter of 2014 and it is likely that growth will be close to zero for the second quarter given industrial action in the mining and metals sectors. We continue to see leading indicators suggesting poor economic prospects.”

On other factors the MPC is likely to include in its deliberations, Du Plessis said while there has been some recent rand weakness versus the dollar, the rand is still substantially stronger than it was when the MPC hiked rates in January.

The current account has also improved in the interim, and South Africa has continued to benefit from strong investment flows into the economy despite the ratings downgrade from S&P and the negative outlook from Fitch.

There has been a moderation in maize prices, which are 30% off their peak and this will have a tempering impact on food price inflation.

Du Plessis said: “There has been some discussion recently about using 25 basis points as an increment for interest rate adjustments and the Bank might be tempted to hike rates by this smaller increment.

“The forward rate agreement market has almost priced in a full 50 basis point increase. However, by hiking rates 25 basis points, the MPC can demonstrate its commitment to taking the inflation target seriously, without having too significant an impact on an already fragile economy.”

The MPC meets on 17 July 2014.