More repo rate pain for South Africans expected this week

A 50 basis points repo rate seems the most likely when the Monetary Policy Committee of the South African Reserve Bank meets on Thursday. Some economists were favouring a smaller increase of only 25 basis points, but that dream has been scuppered by the rand falling during the past week to trade at R19.24 on Monday afternoon.

Higher stages of rolling blackouts are also still looming over the economy and the Bureau for Economic Research (BER) says although a further worsening of the power situation is undoubtedly bad for growth and it would argue against further domestic policy interest rate hikes, it is also inflationary.

“Longer hours without power will increase business operating costs as diesel-powered generators need to run for extended hours and wastage ramps up. Leading retailers already sounded the alarm that any additional costs associated with even more intense power cuts would have to be passed on to the end consumer.”

The BER says in that sense, increasingly, the power crisis is a stagflation (lower growth, higher inflation) shock. “The inflationary impact of rolling blackouts is exacerbated because concerns around the power crisis have arguably been a major contributing factor to the recent rand crash.”

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Weaker rand and more load shedding

The weaker currency will have adverse price impacts, the BER says, but points out that fortunately, in the very near term, the pass-through of the currency sell-off to domestic inflation is muted by subdued international oil prices although it started increasing last week. 

“Even so, given the South Africa Reserve Bank’s (Sarb) primary mandate of price stability, we think the upside price risks from more intense rolling blackouts, the recent stark deterioration in SA’s risk premium and the associated fall in the value of the rand will push the MPC to hike the repo rate by 50 basis points on Thursday.”

The BER expected an increase of 25 basis points before the recent bout of currency weakness, that would signal the end of the tightening cycle. “Even if the MPC moves by 50 basis points, it is now less clear whether that will bring the hikes to an end.”

The uncertain domestic interest rate outlook reflects mixed commentary from leading US central bank (Fed) policy makers during the past week. The BER says even after 500 basis points worth of Fed policy rate hikes over the past year, some members of the rate setting committee doubted whether the US policy rate was sufficiently restrictive to timeously bring inflation back to the Fed’s 2% target.

“Our baseline view remains that the Fed is done hiking, but the conviction is not particularly strong. More Fed hikes would add to the risk that the Sarb also does more after this week and pushes the domestic policy well into restrictive terrain, potentially overdoing the tightening.”

Besides the repo rate decision on Thursday, ongoing rolling blackouts and any further developments on the US-SA diplomatic front, the release of the April inflation rate on Wednesday will also be in focus.

“As with the releases so far in 2023, there is plenty of forecast risk surrounding the number. In part, this is driven by the food component, which has increased by more than expected so far this year. For April, we expect a smaller, albeit still relatively elevated, monthly increase for the food component. The annual rate of increase is also set to tick down a notch to 14.3%.”

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Three reasons repo rate will increase by 25 basis points

David Rees, senior emerging markets economist at Schroders says inflation continued to surprisingly increase over the past couple of months, while the Sarb unexpectedly hiked rates by 50 basis points to 7.75% at its last meeting in March and the further increase in headline inflation is likely to concern policymakers.

“However, there are three reasons to think that inflation should come down in the months ahead and that the Sarb will eventually start to consider easing policy again. Firstly, fuel inflation already begun to drop sharply and should fall a bit further before stabilising.”

Secondly, he says, while the March surprise in inflation was due in large part to the food component, Schroder’s leading indicator suggests that it should now be around its peak. This implies that food inflation will fall by about 10 percentage points by the end of the year. Food makes up about a fifth of the inflation basket and therefore, this could knock about 2 percentage points off headline inflation in the second half of this year.

“Thirdly, tighter monetary policy is a clear downside risk to economic activity and a slowdown or recessionary environment would usually cool core inflation. If that happens, the focus of markets and policymakers would eventually start to shift back from fighting inflation to supporting the economy.”

Economic research group, Oxford Economics Africa, also believe it is likely that the rand’s recent rout could prompt the MPC members to vote for a 50 basis points increase instead of a 25 basis points increase later this week, which was also its initial forecast.

“Tighter monetary policy would do little to boost the ailing rand and could further sap the marginal economic growth that is envisaged for South Africa in 2023.”

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Inflation will increase and repo rate will follow

The Nedbank Group Economic Unit also point out that significant risks for a bigger increase flagged by the Sarb intensified. Load shedding worsened, with no relief in sight as winter drags on, while the rand was also battered over the past few weeks.

“Given the upside risks to the inflation outlook, we expect the Sarb to increase interest rates by another 25 basis points. We believe a 25 basis points increase will be sufficient to tame inflation and facilitate a sustainable decline towards the target range, given that domestic demand is faltering and pockets of financial strain are emerging among consumers.”

However, the unit does not entirely rule out the possibility of a 50 basis points increase due to the uncertainties posed by rolling blackouts and the tumbling rand. “The weaker rand is undoubtedly fueling price pressures. While a 50 basis points hike could help stabilise the currency, this would likely be short-lived given the country’s elevated risk profile.”

Prof Andre Roux, economist at the Stellenbosch Business School, says until a few days ago, many would have hoped that a 25 basis point increase would have sufficed, especially in light of the weak economic growth performance, the persistently high unemployment rate, decline in retail sales and seemingly never-ending misery brought about by pervasive load shedding.”   

Roux says unfortunately the recent exchange rate turmoil seemingly increased the chances of a 50 basis point increase although this move is unlikely to result in a strengthening of the rand but could, all things being equal, help to stem a swift and vicious further weakening of the rand.

“On balance, a 25 point increase would arguably be the more reasonable path to follow at this stage, especially if the effect on the exchange rate of the alleged Russian arms transaction turns out to be short-lived.”