Oh how I long for the good old days of 2013 and 2014, when correctly predicting what the South African Reserve Bank would do with interest rates was so much simpler! Well, sort of. Anyway!
Volatility, both locally and globally, across key indicators has made the crystal balls of even the most skilled financiers hazier than the Singapore skyline. One thing everyone is pretty certain of, however, is that the SARB is not going to reduce interest rates anytime soon. And this allows us to tighten our focus on trying to answer a yes/no question: Will the SARB raise interest rates in May?
Simple, right? Not so much. It seems like every meeting since January 2015 has been a “tough choice” for the SARB and today’s decisions is no different. A strong case can be made for either option and the strongest points look something like this:
Case against an increase:
- Rate already increased: At each of the last three MPC meetings the interest rate has been raised. Many analysts argue that this is a “front-end” increase in anticipation of promised further US Federal Reserve increases and that the Fed’s delay gives the SARB some breathing room.
- Slow growth: The South African economy is facing incredible headwinds because of global economic factors and government failings. Increasing rates now, so the argument goes, will hurt not only consumers who have heavy debt burdens but also businesses (small and gigantic) who require credit to lubricate the wheels of industry. If there is even the tiniest gap many believe the SARB should take it to give South Africa a little more time to adjust.
- CPI has slowed: April CPI figures suggest that inflation slowed when compared to March. As inflation control is the stated aim of SARB MPC this would suggest that its policy is succeeding and it can halt rate increases until there is more clarity on the trajectory of inflation.
- Previous strength in the Rand has bought time: Strongly related to the slowing inflation in April is the strength of the Rand (until last week). As a result import costs have been slightly lower and (as these costs are a major contribution to inflation) this suggests that April’s slowing CPI might continue on into May.
Case for an increase:
- US rate hikes likely in June: A rate increase in the US will likely lead to a strengthened Dollar and a degree of capital flight out of emerging markets (like South Africa). This represents a one-two punch to an already weakened local economy. A pre-emptive increase now might be a bitter pill to swallow but in the longer term it might act to alleviate some of the harm of this increasingly inevitable situation.
- Rand weakness: The Rand has retreated significantly since its positive run in April. Any breathing room this gave, it is clear now, will be short lived. The continued volatility in the local currency means improvements in the Rand cannot be relied upon to sustainably alleviate inflationary pressures.
- Inflation has slowed but is still above the 6% threshold: The SARB MPC’s tries to keep inflation within 3% – 6%. It breached the upper end of that target band in January and has stubbornly remained there. While it has lowered since February the SARB might feel that is must act to continue to ensure this trajectory.
- Oil price remains low but sees growth: Brent crude is trading at close to 70% more per barrel since January 2016. Currently at around $48 a barrel, it is still low but there is now a clear upward trend in price. This, taken with the rapid devaluation in the Rand and its continued weakness, means that the South African economy will likely face significant input costs in the months to come. This will surely exert upward pressure on inflation.
When your positives (slow growth & recent, sizeable rate increases) are themselves pretty negative it makes for grim reading doesn’t it?
In my view all the arguments for a rate increase are based on persistent challenges while many of the arguments against are a based on transient upsides. The SARB might take the tiny gap and leave the rates unchanged. But if it did and the Fed increased rates in June (which is a month before the next MPC meeting) just as oil prices sneak upward we could have a perfect storm of a weak Rand, high costs of fuel and a drought that continues to hammer local production.
This would cause a huge spike in inflation as we import food and oil in Dollar prices hurting the poor the most. The cautious approach therefore, and the one I believe the MPC will take, is to increase the repo rate by 25 basis points to 7.25%.