Markets & economy

Sticking to the slow and steady path of normalisation, for now

At the January meeting of the Monetary Policy Committee (MPC), South Africa’s repo rate was raised by another 25 basis points (bps) to 4.00%.  This was fully priced in by the market beforehand and didn’t catch many off-guard. The more subtle surprise was that the South African Reserve Bank’s implied future path of policy rates was lower than that laid out at the November 2021 MPC meeting.  Undoubtedly, many investors were preparing for the contrary.

US inflation in December 2021 fired up to 7% year-on-year, a 40-year high, and markets are pricing for aggressive rate hiking cycles and quantitative tightening of the Federal Reserve’s balance sheet, which has underscored the recent rout in US technology shares and the 15% year-to-date decline in the Nasdaq Composite Index.

Against such an uneasy backdrop, the SA forward rates market has been pricing 12-month money market deposits at close to a 6% interest rate. This presents quite a gap versus the SARB’s latest model update, which puts the repo rate at ~4.9% by year-end.  Why the disconnect?  We are not in the same ball game as the US, which is experiencing a shortage of labour, pressure on wages, and a strong rise in consumer demand.  The short-lived US enchantment with Modern Monetary Theory and the printing of trillions of dollars has been an imprudent financial experiment, pushing stimulus cheques directly into the hands of US consumers and dousing inflation in lighter fluid.

Conversely, the SA consumer is weak, as evidenced by our low core inflation figure (excluding food and fuel) of 3.4% year-on-year.  As the SARB continues to emphasise, the only way to anchor inflation and continue to be supportive of SA’s consumer recovery is to move gradually.  There are several important local factors, like high administered electricity prices, that are outside of the SARB’s control.  Increasing the supply of energy in SA will arguably better anchor inflation than rate hikes can.

The caveat to the slow and steady SA rate hike guidance is that if US quantitative tightening occurs in a fast and furious manner, this may lead to strong capital flow reversals from riskier assets, like our SA government bonds and the rand, warranting a shift in gears to more rapid rate hikes locally.

Will the actual path of SA interest rate normalisation be gradual or rapid? The MPC prefers the former, but they will act nimbly in the face of danger.

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