The start of a rate hiking cycle, while inevitable, is never pleasant. The hiking cycle the SA Reserve Bank has just embarked on could prove to be one of the more unpleasant in recent history.
The Bank’s monetary policy committee (MPC) decided to raise the repo rate 25 basis points to 3.75%, and its quarterly projection model predicts that hikes of 25 basis points at each of the MPC meetings in 2022 and 2023 will be necessary to contain inflation to the 4.5% target. This heralds a hawkish few years for economic actors and will negatively affect investment decisions in the months ahead.
The Bank is hiking into falling growth momentum and demand that has yet to recover to pre-Covid levels. Unemployment remains crippling, and food and fuel inflation is eroding real incomes. Private sector credit extension is growing at a miserable 1.6% and inflation pressures are not yet evident.
Consumer price inflation is forecast to end 2020 at 4%, compared with the Bank’s 4.5% target. The MPC is responding to rising risks to inflation outside what is happening in this economy. It will have a difficult time communicating its policy stance.
Markets began pricing in imminent hikes as early as March when Brazil and Russia started raising rates. The low din of calls for hikes increased in intensity when the US Federal Reserve confirmed it would taper asset purchases before the end of the year and amplified into November when tapering started. Fifteen of the 22 emerging-market countries included in the Bank for International Settlements data have hiked since March, including all Latin American economies and much of developing Europe.
Asia seems to have been spared pressure for now. The MPC was probably feeling increasingly uncomfortable with the repo rate close to or at record lows in real and nominal terms as the global policy environment becomes less benign.
The US dollar has been strengthening and emerging-market currencies are on the back foot. As an aside, the worst performer of the major developing-market currencies has been the Turkish lira, which has suffered the effects of erratic macroeconomic policymaking and been in free fall since 2015. The lira has depreciated 50% to the dollar since January 2020, compared with the rand’s 11% loss.
For those punting a “heterodox” approach to monetary policy, note that Turkey’s last recorded consumer inflation was 20%, compared with SA’s 5%. President Recep Tayyip Erdogan has vowed to “free Turkey from the scourge of high interest” and the central bank cut rates even as inflation rose. These policies have been damaging to the lira and will filter into the Turkish economy in the period ahead.
Back in SA the rand performed better than its emerging-market peers after the crisis, but softening export commodity prices dragged the currency weaker in the second half of this year. Weakening export commodity prices, coupled with high oil prices, undermine the core underpinning narrative for SA from multiple perspectives. To the extent that it undermines the fundamentals for the rand, the deterioration in the terms of trade is the other factor that caused the more cautious members of the MPC disquiet.
Given this negatively evolving developed-market policy, commodity prices, the rand and inflation risks, the monetary policy spiral was highly predictable. The virtuous cycle that worked in SA’s favour in the second half of 2020 and into 2021 has now turned vicious. This will continue to present a problem for monetary and fiscal policymakers as we move forward.
For the Reserve Bank pressure to hike will continue even as the outlook for growth dims, making the policy stance difficult to communicate and justify. While monetary policy tightening at this juncture is understandable, developments on growth, credit and domestic inflation are likely to continue to make it questionable. In this environment, expect a hiking cycle that is protracted, with potentially long pauses.
• Lijane works in fixed-income sales and strategy at Absa Corporate & Investment Banking.
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.