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Interest rate hike could be on the cards

But economists divided over MPC decision.

JOHANNESBURG – In the lead up to the Monetary Policy Committee’s (MPC) announcement on rates in January economists were unanimous: rates would be kept on hold.

So when the Reserve Bank (Sarb) governor, Gill Marcus, announced that rates would rise by 50 basis points amidst inflationary pressure, analysts were taken aback. At the time all 17 economists polled by Bloomberg expected the bank to keep rates on hold at 5%.

The MPC is due to make another decision this week, but this time around economists are divided in their forecasts. Eighteen of the 31 economists polled by Reuters expect the repo rate to remain unchanged at 5.5%.

Keeping rates on hold

Hugo Pienaar*, senior economist at the Bureau for Economic Research (BER) at the University of Stellenbosch, says the Reserve Bank finds itself in a very tough spot.

The Bank’s mandate requires that it tries to keep inflation in check, but during May inflation quickened to 6.6% year-on-year – well outside the target of between 3% and 6%.

Moreover, the economy is underperforming. It shrank during the first quarter of the year and growth is expected to remain under pressure during the second and third quarters, Pienaar says.

Looking at inflation in isolation, the Reserve Bank may well decide to hike rates but with the economy in such a dire state it is possibly best to keep rates on hold at this stage, he says.

Pienaar expects rates to remain unchanged, although there is some possibility of a 25 basis point hike.

Hiking

Ettienne le Roux, chief economist at Rand Merchant Bank, expects the MPC to hike rates.

He says although they foresee a 50 basis point increase on Thursday, a “compromise” 25 basis point hike won’t be a surprise.

“Irrespective of what happens this week, by end-2015 we expect the repo rate to be at 6.75% (currently 5.5%),” he says.

Le Roux says the Sarb has been warning that the economy is in a hiking cycle since the beginning of the year.

“Recent communication from MPC members has been hawkish, suggesting the Bank is biased towards hiking soon. Indeed, for the Sarb’s credibility to remain intact, it can’t keep on warning and not act,” he says.

Le Roux says at 6.6% in May, inflation has already surpassed the Sarb’s projected peak. Chances are the Bank will therefore have to revise its inflation forecast higher at this week’s meeting.

He expects inflation to increase even further in the coming months and to remain above the upper limit of the target band until the first quarter of 2015.

“Inflation staying above 6% for this long risks dislodging inflation expectations, something the Bank would want to prevent.”

Le Roux says as far as growth dynamics are concerned, much of the weakness is due to domestic idiosyncratic factors. In other words, the economy is not weak because interest rates are high. In fact, real policy rates are negative, ultimately an unsustainable condition for a savings-short economy.

Nazmeera Moola, economist and strategist at Investec Asset Management, says in light of the current weak economic position, it would be easy to use growth concerns to justify keeping rates on hold.

She warns however that there are some risks to this viewpoint.

“Primarily, the inflation outlook is cause for concern: inflation for May was worse than the Sarb expected and this is likely to be the case for June as well. There is also a case to be made that South Africa should have positive real interest rates when the US eventually starts to raise rates. The question is whether the Sarb should gradually move rates higher, or keep rates on hold till the US hikes?”

Moola foresees a rate hike of 25 basis points. She expects voting to be a lot closer than it was in May when the committee voted by 5-2 to keep rates on hold.

Consumers

Theo Vorster*, chief executive officer of Galileo Capital, says although the timing might be uncertain interest rates will go up at some point.

He advises consumers to manage their budgets as if interest rates have already increased by two percentage points.

Hopefully, cumulative increases will be less than that, but consumers have to be prepared in order to avoid financial difficulty, he notes.

* Pienaar and Vorster’s comments were part of an interview for RSG Geldsake with Moneyweb.

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