Geopolitics would have played a big part in interest rates decision

Reserve Bank says for the first time that monetary policy is now restrictive

The Reserve Bank’s monetary policy committee (MPC) unanimously hiked the repurchase policy (repo) rate by 50 basis points (bps) to 8.25% on Thursday in line with market expectations.

Two factors that weighed on the decision are rand weakness against the dollar and interest rates rising around the world. The weakening of the rand since the March MPC meeting reflects domestic factors that are largely outside monetary policy influence.

The Bank is concerned that rand weakness will affect wage settlements and thus boost inflation expectations. The risk is that tightening policy too much will depress economic growth further, which would in turn cause the rand to weaken further and reverse the benefits achieved by interest rate hikes so far.

The MPC will have considered various factors, with geopolitics and its effect on the rand clearly played a big part. Without this, the rand would not have weakened as much. This remains a risk given the diplomatic tensions with the US and pending investigation into alleged arms sales to Russia.

Only after the African Growth & Opportunity Act (Agoa) renegotiations and Brics summit in August will we have a clearer picture. If SA is not excluded from Agoa and Russian President Vladimir Putin does not attempt to physically attend the Brics summit in SA, the risk premium in the currency should compress and lead to some rand recovery.

However, the current account deficit is now expected to be wider in 2023 and 2024, which will also exert pressure on the rand, though it is not surprising, given the moderation in commodity prices and the binding constraint of load-shedding.

Economic growth always matters. In this regard, the Bank has revised its growth forecast marginally upward, to 0.3% from 0.2%. This is surprising, given worsening load-shedding and the effect of the cumulative interest rate hikes on rate-sensitive sectors of the economy, and the moderation in commodity prices reflected in the current account deficit. Be that as it may, growth is stagnant and the revision from meeting to meeting merely reflects the degree of uncertainty in economic forecasting.

The Federal Reserve, European Central Bank and Bank of England are all still expected to hike interest rates further, which will narrow the differential with SA rates. This would have played a role in favour of a larger SA interest rate increase.

Financial or monetary conditions also matter. In times of rising risks to growth and falling business confidence, financial institutions become conservative in their risk appetite. While credit extension has remained strong, we should expect a tightening of credit lending standards until load-shedding, the diplomatic fallout and the global interest rate cycle turn positive for economic growth.

The muted emphasis on the unexpected decline in headline inflation for April, compared with the emphasis that was placed on the two inflation increases in February and March, is curious. It seems the market and the Reserve Bank have an asymmetric response to inflation outcomes, in which they overemphasise upside surprises and downplay downside surprises. Admittedly, rising inflation is more concerning than falling inflation. 

The inflation forecast has changed marginally, with the projection for 2023 rising to 6.2% from a previous forecast of 6.1%. Core inflation, which would matter a lot more and also went up in April while the headline figure moderated, was revised upwards for 2023, 2024 and 2025, to 5.3%, 5% and 4.6%, respectively. This would justify the 50 bps hike because underlying inflation continues to rise relative to previous expectations.

For the first time, the Bank has said that monetary policy is now restrictive, which suggest that it believes the peak is near. There is still a clear risk of more hikes though, conditional on the currency, the risk premium and global factors, all of which are difficult to predict. The next two inflation prints will be key for future decisions.