Comment on the MPC meeting, 7 December 2006

The decision of the South African Reserve Bank to raise the repo rate by a further 50 basis points was widely expected and therefore had little impact on financial markets. However, the important question is whether this was the last increase in the current tightening cycle.

The fact that the MPC Statement is quite hawkish in tone, culminating in the conclusion that the risk to the inflation outlook remains on the upside, indicates that further hikes in the repo rate cannot be ruled out. This contention is confirmed by the governor admitting at the media briefing after the meeting that the MPC had discussed the option of raising the repo rate by 100 basis points, before settling on a 50 basis points adjustment. It is also clear that the Bank wants to see more evidence of a response from the demand side of the economy to higher interest rates. A number of trends in the economy nevertheless indicate that growth in demand is indeed set to slow down.

If the medium-term expected inflation rate is to settle at approximately 5%, the current level of interest rates is however already relatively high in real terms. For example, the real prime rate is then at 7,5%, compared with an average of 6,9% for the past five years. Further increases in the repo rate will imply substantially higher real interest rates, and it is not clear yet that this is the intention of the MPC, as higher real rates are bound to suppress economic growth.

What is becoming increasingly evident, however, is that central banks all over the world have reconsidered their policy stance, and that the abnormally low interest rates of recent years have been an aberration. Financial markets and consumers will therefore have to adjust to the prospect of a higher general level of interest rates than what they have been used to in recent years.