Investors are increasing bets that South Africa’s central bank will prioritise containing inflation over shoring up economic growth and raise interest rates this year.
Forward-rate agreements, used to speculate on borrowing costs, are pricing in a 25 basis-point increase in three months. South African one-year interest rate swaps climbed last week to 6.55%, the highest level since October. All 26 economists surveyed by Bloomberg predict policy makers will leave the benchmark rate unchanged at 5.75% on Thursday.
“Inflation has bottomed and is heading higher and will probably peak above 6% by late this year on electricity price increases and higher oil prices,” Johann Els, senior economist at Cape Town-based Old Mutual Investment Group, which manages the equivalent of $48 billion in assets, said by phone on Tuesday. “The risks are rising of an interest-rate increase toward the end of the year.”
The weakness of the rand and increased fuel and power costs are spurring inflation from February’s four-year low. That comes as the U.S. Federal Reserve prepares to raise its key rate, putting pressure on the Reserve Bank to act even as electricity shortages constrain economic growth. The inflation rate jumped to 4.5% in April, less than estimated, from 4% in the previous month, the state statistics agency said on Wednesday.
The central bank’s mandate is to keep inflation within a band of 3% to 6%. The benchmark interest rate has been on hold since July, when it was increased by a quarter of a percentage point.
A decline in oil prices last year helped to bring inflation under control, allowing the Monetary Policy Committee to support an economy that grew at the slowest pace in 2014 since a recession five year before. Since Jan. 13, Brent crude has jumped 39%.
While the MPC doesn’t need to respond to temporary breaches of the target, it has to react to a sustained breach, Reserve Bank Governor Lesetja Kganyago said in an interview with the Johannesburg-based Financial Mail published on May 13. Deputy Governor Daniel Mminele said in April that policy makers have less flexibility to continue keeping borrowing costs on hold because the outlook for inflation had deteriorated.
At its last meeting in March, Kganyago said possible further increases in power prices added to risks to the inflation outlook. Eskom Holdings SOC Ltd., the state-owned company that supplies about 95 percent of the nation’s electricity and is struggling to meet demand for power, has asked for a 25 percent jump in tariffs for this year.
The rand fell 0.4 percent against the dollar to 11.9505 by 10:30 a.m. in Johannesburg on Wednesday, extending the decline over the past year to 14 percent. The inflation rate generally increases as much as 2 percentage points for every 10 percent depreciation in the currency, according to the central bank.
The bank faces “a real dilemma” because it needs to show its commitment to meeting the inflation target at a time when growth is faltering, said Kristin Lindow, senior vice president at Moody’s Investors Service.
“If they felt they were giving the wrong signals by staying on hold, that they would tolerate higher inflation, then I think they would tighten” rates, she said in a May 18 interview in Cape Town. “I don’t think they want to risk the credibility” of the inflation-targeting policy, Lindow said.
The National Treasury forecasts the economy will grow on average 2.5 percent a year from 2015 to 2017, half the rate the government is targeting by 2019 as it seeks to slash a 24 percent unemployment rate.
“Inflation will probably be picking up some momentum toward the end of this year,” Arthur Kamp, chief economist at Sanlam Investment Management, said by phone from Cape Town. “If the Reserve Bank’s forecasts show a continued rise into next year, it will be difficult for it to sit on the sidelines.”
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