How much will higher interest rates hurt? Higher rates usually impact economic activity with a lag, so it is probably too soon to tell.
In the developed economies where rates have increased dramatically from ultra-low levels, the answer so far is not much. We have seen banking turmoil, or at least in some parts of the banking sector, but little impact on employment or consumer spending. At any rate, the banking panic seems to have eased, thankfully, and casualties have been limited. At least, the acute phase appears to be over, though we might still enter a chronic phase of uncertain timing, breadth, and severity as banks cut back lending, which in turn causes some borrowers to default, inflicting losses on the banks. Consumers and corporates are also still switching deposits from smaller to larger banks and money market funds.
Big questions remain on what the ultimate impact of the rate hikes to date will be on economic growth, inflation and ultimately, financial markets. Today we’ll focus on South Africa.
Take a hike
The Reserve Bank’s Monetary Policy Committee (MPC) increased the repo rate by 50 basis points to 7.75%. This was more than expected, supported by three members against two who preferred 25 basis points. The MPC is concerned over the upside risks to inflation and downside risks to the rand. It is also particularly worried that consumer, worker and company expectations of future inflation could rise further, becoming self-fulfilling and feeding into sustained inflation above the 4.5% mid-point of the target range.
The Bank expects inflation to average 6% this year, 4.9% next year and 4.5% in 2025. Consumer inflation rose to 7% year-on-year in February, with elevated food inflation largely to blame. However, there was also a jump in core inflation, excluding food, fuel and energy prices. It rose to 5.2% year-on-year. Headline inflation should subside during the year, helped along by an 8% decline in the rand oil price in March.
The MPC hiked despite a bleak economic growth forecast. While central banks in the developed world ploughed ahead despite financial stability risks, the Reserve Bank went ahead despite the possibility of economic stagnation. Real economic growth of only 0.2% expected this year, with 1% forecast for next year and 1.1% in 2025.
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