South Africa’s rate hike leaves uncertainty over the rand

The South African Reserve Bank has fired the starting gun on monetary policy normalization, but economists do not expect the hiking cycle to be plain sailing.

The SARB on Thursday hiked its main repo rate by 25 basis points to 3.75% from its record low amid growing concerns about upside inflation risks. The central bank raised its consumer price index forecast from 4.4% to 4.5% in 2021, and from 4.2% to 4.3% in 2022.

The hike marks the first step to unwinding 275 basis points of cuts implemented since the start of the Covid-19 pandemic, but the Monetary Policy Committee split its vote 3-2, indicating conflicting sentiments within the SARB as it looks to support the recovery while addressing inflation fears.

Headline consumer price index inflation was a modest 0.2% month-on-month in October, an annual climb of 5%.

In his statement, SARB Governor Lesetja Kganyago noted that elevated oil and energy prices pose upside risks to the short-term inflation outlook.

Jeff Gable, head of macro and fixed income research at South African bank Absa, told CNBC Friday that the repo rate rise had come a little earlier than many economists had expected, and showed the bank’s concern about upside risks to inflation. However, projections remain around the center point of the SARB’s target for now.

“We know that in South Africa we have tens of millions of vulnerable South Africans not really in a position to be able to protect themselves from inflation, and so [we have] a Reserve Bank here that has needed to be talking tough about inflation throughout the cycle,” Gable said.

“So this signal, this first rate rise a little earlier than we expected, is certainly an indication, I think, that they want to stay on top of it.”

A gradual hiking cycle

Gable said it remains to be seen whether the unwinding of the SARB’s accommodative position comes in successive policy meetings, or whether the market will be on tenterhooks each time the MPC gets together over the next couple of years.

Virag Forizs, emerging markets economist at Capital Economics, said in a note Thursday that the decision indicates a slower tightening cycle than markets had anticipated.

Kganyago said the MPC believes a “gradual rise in the repo rate will be sufficient to keep inflation expectations well anchored and moderate the future path of interest rates.”

“This dovish bias probably helps to explain why the rand initially weakened against the dollar following the decision,” Forizs said.

“In addition, MPC members will probably want to keep monetary policy as accommodative as possible to continue supporting the economy.”

Capital Economics has penciled in 150 basis points of hikes over the next two years, with the repo rate rising to 4.5% by the end of 2022, and to 5.25% by the end of 2023.

By contrast, Forizs highlighted, the market is pricing in around 250 basis points of hikes within the next 18 months.

Growth outlook…