Delivering the monetary policy committee speech last week, South African Reserve Bank (Sarb) governor Lesetja Kganyago announced that the Sarb would raise the repo rate by 25 basis points to 6.75%. The decision was informed by the fact that inflation has been edging towards the upper 6% level. The market saw the decision as hawkish, but with the consumer price index (CPI) for October registering at 5.1% year-on-year, the Sarb was bound to act at some point.
A more chilling prospect is presented by the widening differential between the CPI and the repo rate, which is bound to complicate Sarb’s policy actions if it persists. “The difference between the repo rate and the CPI is known as the real interest rate,” says Montfort Mlachila, the International Monetary Fund’s senior resident representative in South Africa. “If the real interest rate is rising, it will increase the funding cost for companies but it may also increase savings.”
This year, South Africa’s real interest rate eased from about 2.7% in Q1 to about 1.5% in Q3. But in the past two years, as the US Federal Reserve normalised, the Sarb embarked on a relatively accommodative stance. The two inverse monetary actions have seen the variance between Sarb and Fed interest rates exacerbate pressure on the rand. “The differential between US and SA interest rates fell from 6.7% to 4.3%, with the rand depreciating alongside,” says Annabel Bishop, Investec’s Group economist. ” SA has cut interest rates as the US has hiked, and the rand has weakened markedly.”
Dovish in the US
Fed chair Jerome Powell, addressing members of the Economic Club of New York this Wednesday, was more dovish. He confirmed that rates were currently “just below neutral” – this coming barely two months after he said interest rates were “a long way from neutral”. Powell’s tone sent the Dow Jones Industrial Average up more than 600 points as equity markets took the comment as the Fed being aware of the risks of tightening too soon.
From South Africa’s perspective, the dovish tone signals a much-welcome respite as the widening between the Fed’s interest rates and Sarb’s repo only adds pressure to the rand. Sadly, imminent US interest rate hikes in 2019 will play a prominent role in South Africa’s CPI inflation/repo rate differential – and not even President Donald Trump’s rants at Powell will avert the Fed’s planned actions.
However, Bishop cautions that: “SA is likely to see the difference between CPI inflation and its interest rates widen slightly next year, rising from 1.5% to 2%, which would typically herald some mild rand strength, if not stabilisation of the domestic currency, other factors unchanged.”
Private sector credit
One of the most palpable effects of a widening real interest rate is expensive credit. Growth in private sector credit extension is already feeling the pressure – dropping 5.8% year-on-year in October from 6.3% year-on-year in September 2017. With third-quarter unemployment edging up to 27.5% and National Credit Regulator data revealing that the rejection rate of new credit applications climbed 1.6 percentage points to 50.1% in the second quarter, South Africa’s private sector could do with some cheaper money.
Sadly, forecasts paint a dismal picture as the interest rate and CPI inflation differential is only expected to widen more next year.