PREDICTION CORRECT: PRIME LENDING INCREASED TO 10.25%
South Africa’s first rate announcement of the year will be made at 1PM today and the bond market seems to have already decided that the rate will be increased by 0.5% with bonds pricing in line with this move. The vast majority of economists agree that a rate hike will occur with the only argument being an increase of 0.25% or 0.5%.
Why this certainty? The Rand and inflation. The Rand has been in decline since early 2015, a decline made somewhat steeper by China related jitters in September and Zuma related jitters in December. This kind of a decline would have put massive upward pressure on inflation even at a time without drought but now we must also import millions of tons of maize in addition to the other products we already import (oil, high-tech consumer goods, parts for machines etc.)
The SARB’s stated objective is to maintain inflation within a 3% -6% target band and it does this by manipulating the interest rate (and thus the supply/cost of credit).
Inflation for December quickened to 5.2% and is expected to breach 6% in January making a rate increase necessary, at least in the thinking of the SARB. Increasing the interest rate has also, traditionally, had a positive impact on the Rand exchange rate as increased rates offer better returns on investments (bonds). Which makes an interest rate even more tantalizing and seemingly desirable.
Unfortunately, the problems that are causing the slide in the Rand and the quickening of inflation are out of the control of the SARB. The top three factors (or grouping of factors) are:
1) Global Downturn
Currently there is a global economic slowdown and our single biggest trading partner, China, is at the centre of it. This has sparked massive capital outflows from emerging markets, like South Africa, and has seen commodity prices (from gold to oil) steeply decline.
Food prices are set to jump rapidly as planting seasons pass and quotas are not met. Millions of tons of maize are already on their way to South Africa but there might still be a shortfall later in the year. That means mielie pap, the staple food of South Africa, might disappear from shelves.
The drought is also decimating other crops and livestock will suffer too. Unsatisfied demand would already have spiked the prices. But the decline of the Rand has made the cost of imported food somewhere close to 40% more expensive than a year ago.
3) The Rand (actually: Government)
US Dollar strength, the drought and the global downturn are only part of the problem with the Rand. The reality is that there are deep seated structural flaws in our economy that are inhibiting growth. If these flaws did not exist, we would still have seen a decline, true, but we would have been better insulated.
There is an incapacity in our government to manage the sophisticated economy it finds itself heading and the many missteps (think SAA, PetroSA, Eskom, Nene) have undermined confidence and damaged our economy more than the drought and global down turn. In light of this fact any improvements to inflation and the Rand in the face of an interest rate hike are destined to be short lived.
Why do I think it is so bad?
Traditionally, inflation is driven by a growing economy where more people have more money to spend. This pushes up demand and this pushes up prices. Inflation. That growth in the economy is often spurred by cheap credit that in turn is used to finance factory or office expansions or investments in new products. Does that sound like South Africa?
We had the cheap credit but people used it to buy homes, cars, makes ends meet or (let’s be honest) acquire bling. Expansions were stifled and massive job creation has not happened and our economic growth is anemic (and set to worsen). We are caught in the the ‘stagflation’ trap (I’ve been banging on about this since 2014).
The SARB is as likely to influence the global economy as it is to influence the weather. And even the SARB, SARS and our finance ministry, once the crown jewels of our bureaucracy no longer shine so bright in the face of government meddling.
The manipulation of the interest rate, this tiny lever the SARB has, cannot shift the weight that is crushing us. In fact, there is a strong possibility that because of stagflation these rate increases (yes, more are predicted) might hurt us more than they help. Read more about this here.
ANYWAY, enough ranting. I predict:
A 50 point increase (0.5%) increase now with the aim of improving the Rand and reducing inflation. This is in line with SARB’s projections and gives them some breathing room. They will use this to wait and see what happens globally and to avoid raising the rates again too close to the election (somewhere between May and August).
Tomorrow’s predicted rise will push the repo rate up to 6.75% which in turn will see the prime lending rate reach 10.25%. This is the first time prime has breached 10% since March 2010. I’ll be writing a piece about what this means for your pocket next week.