ZAR weakness will prompt the SARB to deliver another bold rate hike
There can be no doubt that expectations of interest rate increases earlier this year were for a much more moderate outcome than what is materialising. There are three main reasons for this. Firstly, internationally, underlying inflation has turned out to be somewhat more sticky than previously anticipated. Earlier this year, hopes had been that interest rates would peak at lower levels than what has materialised.
Although food and fuel prices globally have moderated considerably, the passthrough effect of the initial inflationary impulse caused by the lifting of lockdown restrictions and the shortage of supplies of goods and services as a result of the coronavirus, has proved to be longer lasting than anticipated. Inflation domestically has turned out to be far higher than had been anticipated at the beginning of the year.
The other factor underpinning inflation expectations is the sustained weakness in the rand. Initially a deterioration in the current account and budget balances was a factor. An intensification of load-shedding exacerbated the likelihood of lower economic growth and with that a deterioration in the country’s fiscal situation since lower economic growth would generate lower tax revenues.
Then the prospect and materialisation of grey listing of the country for not doing enough to counter money laundering also weighed on the currency. This was seen to reduce the likelihood of South Africa attracting investment.
Finally, more recently, the investment attractions of South Africa have been dealt a further blow by the government’s dalliance with Russia which has been irritating South Africa’s most important Western partners, raising the possibility of sanctions or the termination of favoured trade conditions between those countries and South Africa.
Be that as it may, the real depreciation has been of such magnitude that it has exerted upward pressure on as businesses have been forced to pass on to consumers the increased cost of imports.
Expectations
As a result of these inflationary pressures, the standard expectation until recently had been that the Reserve Bank would be inclined to increase the repo rate by a further 0.25% to 8.00% from 7.75% at its forthcoming MPC meeting this week. Such an increase would be in line with the magnitude of the increases announced by the Federal Reserve Board, Bank of England and European Central Bank in recent weeks.
However, sentiment regarding prospective rate increases has shifted dramatically in recent weeks towards expecting the Bank to raise the repo rate by at least 0.50%. This situation has come about primarily because of the marked further depreciation in the rand against all currencies in the past fortnight, of between 5% and 7%.
This is bound to generate additional inflationary pressures domestically, which were previously not foreseen. The latest depreciation of the rand was brought about by allegations that South Africa sold arms to Russia. Such a move could open the country to the possibility of enduring sanctions imposed by countries that have regarded the invasion of Ukraine by Russia as being illegal. It also has raised the ire of many international investors in the West who are likely to be less inclined to commit to South Africa.
As highlighted in the monthly rates dashboard released on Friday, Against the backdrop of the sharp depreciation in the ZAR and soaring inflation expectations, both of which will concern policymakers, we have revised our forecast for the upcoming May MPC meeting to a 50bps hike. While this is our base case, we must flag that there is a reasonable probability that the SARB could deliver an even larger hike, in the range of 75-100bps, to help stabilise the weakening ZAR.
Bottom line:
As a result of inflationary pressures, the standard expectation until recently had been that the Reserve Bank would be inclined to increase the repo rate by a further 0.25% to 8.00% from 7.75% at its forthcoming MPC meeting this week. Such an increase would be in line with the magnitude of the increases announced by the Federal Reserve Board, Bank of England and European Central Bank in recent weeks. However, sentiment regarding prospective rate increases has shifted dramatically in recent weeks towards expecting the Bank to raise the repo rate by at least 0.50%. This situation has come about primarily because of the marked further depreciation in the rand against all currencies in the past fortnight, of between 5% and 7%. On forward markets, the mood has turned towards expecting not just a 0.50% increase at the MPC meeting on Thursday, but a further two sets of increases of 0.25% at forthcoming MPC meetings in July and September.