July 2014 Rates Watch – SARB & Stagflation

I’ll keep it brief as there has effectively been little change in the South African economy since my last prediction…

“Put your money where your mouth is” best describes the SARB’s current predicament. They’ve been warning us about rate increases for 6 months but haven’t acted. The credibility of these warnings and, by extension, the SARB is now under threat and action must surely be taken soon to allay creeping doubts.

Unfortunately South Africa is becoming stuck in the so called ‘stagflation trap’: the economy continues to stagnate while inflation continues to rise. This situation is not something that the SARB can tackle alone and rate hikes might have no (or even a negative) effect.

Economic Stagnation + Inflation = Stagflation (it's a real thing)

Economic Stagnation + Inflation = Stagflation (it’s a real thing)

The major contributor to stagnation remains industrial strike action: the platinum strike has simply been replaced with a larger strike by NUMSA continuing pressure on economic growth. Strike action contributed to a contraction in the economy in the 1st quarter of the year and this forced downward revisions of growth forecasts and led to further ratings downgrades.

On the inflation side: despite my hope, May’s rally in the Rand was short lived and did nothing to bring inflation down closer to 6%. Spikes in the oil price didn’t help either and though it has recently dipped back down below $100 mark it will likely be a very volatile across the next few months. This is thanks to increasing violence and disruption in the Middle East, greater than expected growth in China and worse than expected performance in North American production.

The Reserve Bank remains trapped and faces the same stark choices it did in March and May: raise the rate and put pressure on the economy or keep the rate the same taking a knock to credibility and watch inflation figures tick upward.

Again my prediction is for an increase of 0.25%. The rate cannot be held at these low levels indefinitely and this smaller change (the rate was last change by an increment other than 0.5% in 2000) remains the best compromise in a difficult situation.

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