Interest rate pain expected for South Africa

The South African Reserve Bank (SARB) Monetary Policy Committee (MPC) will face a difficult decision when it meets at the end of May, as the country’s inflation trajectory looks increasingly dicey.

The MPC’s next interest rate move will be announced on Thursday, 28 May, following a critical CPI release coming just a week before.

Consumer price index (CPI) data for March, published in April, showed a small bump in inflation to 3.1%, following a 3.0% reading in February.

While the March print came after the United States’ war in Iran kicked off on 28 February, it did not reflect the impact of the war, especially the rising fuel prices, which hit April.

According to Investec Chief Economist, Annabel Bishop, the fuel price shock of April will only reflect in next week’s inflation data, where it is expected to push CPI upwards.

Some projections have been more muted, seeing inflation at 3.7%, while others have been more extreme, pushing over 4.0%.

The SARB’s current inflation target of 3% has a tolerance band of 1% either way, giving a broader target range of 2% to 4%.

This allows a deviation in CPI inflation from the 3.0% y/y target for a period of time—but not if it settles away from 3.0% y/y more permanently, Bishop said.

While central banks typically look through temporary inflation shocks, the picture changes when they become more entrenched.

In the months since the Iran War erupted, economists have consistently warned that the longer it persisted, the greater the risk that second-round inflationary shocks would persist.

Bishop said the MPC will be looking at these shocks.

“The SARB will be looking for second-round effects in the inflation data over Q2.26 and indeed over the remainder of the year, indicating that significant evidence of such would drive interest rate hikes,” she said.

However, the economist warned that the SARB has indicated it may be preventive and hike before the second-round effects appear.

“This hawkish tone is reflected in multiple rate hikes factored into the Forward Rate Agreement curve in South Africa’s financial markets,” she said.

Some solace is that real interest rates are currently very restrictive, with the repo rate currently at 6.75%, Bishop said.

Because of this, she said she expects the SARB to skip rate hikes at its May meeting, looking through the April jump in inflation.

But this is no guarantee, with the clear risk that its “extreme hawkishness” may result in the SARB hitting the hike button sooner rather than later.

“The SARB has said that striking pre-emptively, by raising interest rates sooner, can result in fewer interest rate hikes overall,” Bishop said.

She added that the SARB favoured this approach previously in the last price shock, which occurred as a result of the Russia-Ukraine war in 2022.

“Consequently, there is some risk the MPC may decide to do so again, hiking the repo rate in May instead of waiting until July at least to assess second-round effects.”

If the SARB leans toward the same approach, the economist said a 25 basis-point hike could be looming in two weeks’ time.

Source: https://businesstech.co.za/news/finance/860449/interest-rate-pain-expected-for-south-africa/