In November, the South African Reserve Bank’s monetary policy committee (MPC) raised the repo rate by 25 basis points to 3.75% from a low of 3.5%. This was the first time in three years that rates have been raised and appears to be in response to the Bank’s concern around the upside risk of inflation.
Even after this hike, Reserve Bank governor Lesetja Kganyago said the bank’s monetary policy stance remains accommodative. Real interest rates, in other words interest rates after subtracting inflation, remain at very low levels.
The rate increase indicates the start of a normalisation of monetary policy. The consensus amongst economists appears to be that rates will be hiked a further 100 basis points by the end of 2022 and an additional 100 basis points in 2022. In total, markets are pricing in eight more increases: one for each quarter of 2022 and 2023.
The big question is whether inflation – which needs to be accelerating – and economic growth – which needs to be rising – justify these increases? Although inflation rates will probably justify these hikes, growth rates are unlikely to do the same.
The yields on nominal bonds and inflation-linked bonds are a good indicator of what the market expects inflation to do in the coming months. All indications are that the market expects inflation in the region of 5.5% to 6.5% which is manageable. Inflation is only a concern if it starts to breach 7% or 8%. The expectation is that the majority of the inflation in the medium term will be driven by supply-side constraints including the high cost of electricity and fuel.
What is becoming increasingly apparent is that the local economy has become mired in a low-growth quagmire. Far from inflation being a problem, the economy is unable to generate demand-pull inflation.
The Reserve Bank’s decision to hike the interest rate follows a decision by the US Federal Reserve to begin withdrawing its bond purchase programme by US$15 billion a month. Its first interest rate hike is likely to only occur in mid-2022. Other countries have followed suit, including Canada, which ended its bond purchases earlier than expected. The Bank of England also plans to increase interest rates next year. The European Central Bank, while leaving key interest rates unchanged, has lowered the pace of its bond purchases.
All indications are that the Reserve Bank’s MPC is also concerned with interest rates globally, local interest rates will come under pressure if US interest rates rise faster than expected, or by more than expected.
If the interest rate cycle has indeed turned as expected, there will be a small benefit for money market investors who will see marginally higher returns.
Should interest rates continue to rise, indebted and unemployed consumers will be placed under even more financial pressure, particularly when combined with increased utility and fuel prices. According to Statistics South Africa, the country’s unemployment rate hit a new high of 34.9% in the third quarter.
The unemployment figures are even more concerning under the expanded definition which includes discouraged jobseekers. Under this definition, unemployment has risen to an alarming 46.6%. The youth unemployment rate is currently 66.5%. The fact that close to half the economically active population is jobless is a worrying indicator of the health of the economy. Rising interest rates certainly don’t auger well for this sector of the population.
Predictions, however, are just that. It is only with hindsight that we will really understand whether the current inflation is structural or transitory and will recede in time.