The rand plummeted to a record low on Thursday after the Reserve Bank hiked rates to a 14-year high and stoked market fears about the outlook for the currency and for the economy.
In a rare unanimous decision, the Bank’s monetary policy committee opted for a 50 basis point (bps) rate hike, in an effort to curb an inflation outlook which has worsened on the rand’s sharp slide in recent weeks.
The hike was broadly in line with analysts’ forecasts, but some in the market had expected the Bank might surprise with a more hawkish 75 bps hike. This seemed to be one reason the rand fell to R19.75 to the dollar immediately after the announcement, and to R19.79 by Thursday evening, down 2.57%, with bond yields also weakening significantly.
Another reason for the rand’s slide was the Bank’s warning that “further currency weakness appears likely”, because of upside inflation risks, load-shedding and a worsening balance of payments and fiscal outlooks. The Bank’s comment seemed to spook the market — as did concerns about the risk that the rate hike could tip the economy into recession, and so add to the bad news weighing on the rand and inflation.
Goldman Sachs economist Andrew Matheny said the market’s reaction suggests it had interpreted the Bank as having a more bearish cyclical view on the economy than the market had previously thought, with implications for the rand.
The Bank has now increased rates by a cumulative 475 bps since the start of the hiking cycle in November 2021 and governor Lesetja Kganyago said monetary policy is now in “restrictive” territory for the first time but there will be no relaxation of policy until the inflation trajectory changes and inflation heads towards the target range.
“In the long term South Africans will benefit because we will bring down inflation and the cries of South Africans have been that inflation is eroding their income,” Kganyago said. “We have got to take the short-term pain in the interests of long-term gain.”
Some economists have argued that the Bank risks over-tightening rates, which could tip the economy into recession and weaken the rand further, adding to inflation pressures and creating what Matheny has called a “negative feedback loop” that would mean interest rates would have to be tightened even further. However, Kganyago said on Thursday that the risks of undertightening are greater than of overtightening. Doing the necessary tightening even in an economy that has come to a halt is a “necessary evil” to anchor inflation expectations, he said.
“If we undertighten and are found to have been wrong the markets and the price setters will not trust us and we will have to be more aggressive; however, if we discover we have overtightened the correction is swift,” he said. “We have to take the bitter medicine to avoid surgery and intensive care.”
At 8.75%, the benchmark repo rate in real, inflation adjusted terms is now at or above the 2.4% the Bank regards as the neutral interest rate. The Bank’s decision came in response to headline inflation which it now expects will average 6.2% this year (up from the previous forecast of 6%) and 5.1% next, with headline inflation expected to remain above the upper end of the inflation target until the third quarter of this year. It will revert sustainably to the 4.5% mid-point of the inflation target range only by the second quarter of 2025. The Bank is also concerned about the market’s longer-term inflation expectations, which Kganyago said have increased strongly, to 6.5%.
He said things could be done by other agents of government to help to arrest inflation, such as municipal rates and taxes and in areas such as electricity and water — “if all the price setters in the public sector play ball and only adjust prices in line with inflation in the long term it will help to bring inflation down.”
Kganyago said the monetary policy committee discussed a 75 bps rate hike but it also discussed 50, 25 and zero.
The Bank has fractionally lifted its growth forecast for this year to 0.3%, from 0.2%, but it still estimates growth to be below the economy’s extremely low potential.
The Bank’s decision came after it surprised the market with a higher than expected 50 bps hike in March. But it is now working with a starting point for the rand forecast of R18.68, compared to R17.80 at the time of the March meeting, and it expects currency markets to remain volatile and sensitive to idiosyncratic shocks.
The market is now mulling whether this hike will be the last. RMB Morgan Stanley thinks the Bank could again lower its core inflation forecast at the next meeting but expects a further, final 25 bps hike in July.
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