As inflation continues to ease, analysts have questioned whether the first interest rate hike in two years was warranted.
The Reserve Bank’s monetary policy committee (MPC) raised the repo rate by 25 basis points (bps) in November 2018 — a move that was hotly debated by the committee and resulted in a split vote.
However, some economists argue that the hike was a necessity given the persistent risks to the inflation outlook and the Bank’s longer-term forecasts, which look at the next two years.
The hike was a pre-emptive exercise in response to long-term risks of inflation, including tighter financial conditions such as interest rate hikes in the US, a weaker exchange rate, a high wage rate, oil prices and rising electricity and water tariffs.
The move split analysts. While some welcomed the hike, others questioned the timing given the fragile state of the economy and the strain consumers were already feeling.
Since then, inflation has continued to ease. It is now well below the midpoint of the central bank’s target range of 3%-6% and growth still remains very weak.
“In November, we argued that the 25 bps hike they instituted at the time was a mistake — and that the Bank’s inflation forecasts were wrong … Given the weakness of growth, the current CPI forecasts warrant the consideration of rate cuts,” Investec Asset Management deputy MD Nazmeera Moola said.
Consumer inflation decelerated to 4% in January, data from Stat SA showed last week. This was much lower than the markets’ forecast of 4.3% from 4.5% in December.
“The somewhat surprising drop in the growth rate of inflation may beg the question if the rate hike in the last quarter of 2018 was necessary,” PPS Investments portfolio manager Luigi Marinus said.
The Bank’s tone has also changed markedly. In January, the MPC unanimously decided to keep the repo rate unchanged at 6.75% amid an improved inflation outlook and mediocre economic growth prospects. Notably, there was a significant decline in the Bank’s inflation forecasts, with inflation expected to remain below 5% through 2019.
Earlier in February, deputy governor Daniel Mminele said: “The jury is still out on several of the potential causes of this latest disinflationary trend, and whether they will last.”
He said the Bank still remains concerned about risks to the outlook.
“Demand remains weak and credit creation is sluggish, and in many countries these would be sufficient conditions for inflation to fall further. Equally, many risks, both external and internal, could result in higher inflation should they materialise,” Mminele said.
However, Capital Economics economist John Ashbourne argued that inflation is likely to continue to fall, increasing the chances that the Bank may embark on rate cuts. Lower oil prices and a stronger rand have eased inflationary concerns while recent comments suggest the Fed isn’t as hawkish on rates.
“January’s weaker-than-expected inflation figure strengthens our view that rate hikes are now off the table,” Ashbourne said.
With inflation likely to fall further below the midpoint of 4.5%, which the Bank prefers to target, and the US Federal Reserve’s tightening cycle coming to an end, there’s a growing chance that the 25 bps could be brought forward to later in 2019, he said.
“Policymakers struck a much more dovish tone at their previous meeting, and we expect that this is likely to be stepped up in March,” Ashbourne said.
Investec economist Kamilla Kaplan said current risks to the inflation outlook include rand depreciation, a rebound in the international oil price and above-inflationary increases in electricity tariffs.
The risk to SA interest rates is still to the upside over the medium term, Stanlib chief economist Kevin Lings said.
“The Reserve Bank acted preemptively to contain any breach of the upper target band,” FNB chief economist Mamello Matikinca said.
There is enough evidence to convince the MPC to leave interest rates on hold until about November, when the MPC is forecast to resume its mild tightening cycle in anticipation of higher inflation in 2020, Nedbank economist Johannes Khosa said.
Either way, the Bank is likely to hold off on another move for some time. The next repo rate announcement, on March 28, is expected to result in an unchanged stance. The question now becomes, to cut or to hike later in 2019 — and analysts are still split.
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