SA Reserve Bank hikes repo rate to 7%

The South African Reserve Bank decided to increase the repo rate (repurchase rate) by a further 75bps to 7.00% at its MPC meeting last week. The decision was not unanimous, with two members of the MPC preferring an increase of 50bps. The decision was in line with market expectations, although a couple of analysts (strangely) had argued for a hike of 100bps. The MPC statement highlighted the upside risks to SA inflation, including upward pressure on salaries. The fact that two MPC members voted for a hike of 50bps suggests that SA interest rates are getting close to a peak, but also that the Reserve Bank is now more aware of the downside risks to growth (see discussion below) as well as its favourable inflation forecast at end 2023. Listening to the press conference after the rate decision, it seems fair to argue that the repo rate is not yet at a peak, especially given the most recent increase in core inflation.

The Reserve Bank last adjusted interest rates on 22 September 2022, when it increased the repo rate by 75bps. Since November 2021, the repo rate has now increased by a total of 350bps. South Africa’s prime interest rate should now increase to 10.50%.

Critically, according to the MPC, “higher than expected inflation has pushed major central banks to accelerate the normalisation of policy rates. This has tightened global financial conditions and raised the risk profiles of economies needing foreign capital” – which would include South Africa. Consequently, “capital flow and market volatility is elevated for emerging market assets and currencies”.

The Reserve Bank, once again, highlighted the upside risks to SA inflation, which is still focused on a wide range of factors including oil, food administered prices, the rand exchange rate and salaries. In particular, the Bank’s food price inflation forecast is revised higher to 6.2% in 2023, up from 5.5% previously. And its estimate of headline inflation for this year and next is slightly higher at 6.7% and 5.4%, respectively. For 2024 and 2025 headline inflation is expected to average 4.5%.

In contrast, the risks to SA economic growth are now to the downside. This means that the MPC has once again changed its risk assessment regarding SA’s economic growth. Back in July 2022, the MPC highlighted that the “risks to SA growth are weighted to the downside”. However, in its 22 September MPC statement, the risk to SA economic growth was viewed as being “neutral”, despite ongoing severe electricity outages, higher interest rates and downward revision to global growth. The Bank’s SA GDP growth estimate for 2022 was revised down slightly to 1.8% from 1.9% previously, while its 2023 estimate was reduced significantly to 1.1%, having been revised higher in September from 1.3% to 1.4%. For 2024, SA GDP growth is forecast at a still modest 1.4%, down from 1.7% previously. For 2025, SA GDP growth is estimated at only 1.5%, despite government’s promises of increased fixed investment spending.

Overall, the latest interest rate decision needs to be viewed within a global interest rate context. It can be argued that SA should not increase interest rates aggressively considering the current weak economic environment, high food and fuel prices (which are difficult for most households to avoid), high unemployment and service delivery constraints. However, the Bank has repeatedly highlighted its desire to ensure that SA inflation is anchored around the mid-point of the inflation target, and that allowing SA inflation to remain above the inflation target unchallenged is unacceptable and would undermine the recent gains in getting inflation expectations lower. Without rate hikes, SA has a high risk of quickly developing a self-reinforcing upward spiral in inflation, driven by wage demands and a weaker exchange rate.

At this stage it still seems reasonable to assume that the Reserve Bank is likely to continue to hike rates during the early part of 2023 – possibly by a further 50bps at the first MPC meeting in 2023, followed by a final hike of 25bps at the second MPC meeting. However, is also seems fair to assume that once inflationary pressures have abated more convincingly, the bank will want to pause and more clearly assess the need for any further rate hikes – especially if SA’s inflation rate is heading convincingly towards 4.5% at the end of 2023 and the major central banks are also looking to end their own rate hiking cycle.