South African Reserve Bank surprises financial markets with big rate hike

Lesetja Kganyago

South Africa surprised financial markets by delivering its biggest increase in borrowing costs in almost two decades and signalled a faster pace of hikes through next year.

The monetary policy committee raised the repurchase interest rate to 5.5% from 4.75%, Governor Lesetja Kganyago said Thursday in an online briefing. It’s the biggest hike since September 2002 and aligns the South African Reserve Bank with other global central banks unleashing the most aggressive tightening of monetary policy in a generation to cool surging inflation.

The implied policy rate path of the bank’s quarterly projection model, which the MPC uses as a guide, now indicates its key rate will be at 5.61% by year-end, compared with its May forecast of 5.3%. It’s seen at 6.45% by the end of 2023, up from 6.21%.

The rand gained as much as 0.9% after the announcement and traded 0.5% stronger at 17.0768 per dollar by 5:32 p.m. in Johannesburg, while an index of local bank stocks rallied as much as 2.6%. The yield on government debt due in 2026 fell 19 basis points to 11.2%.

Only seven of the 20 economists in a Bloomberg survey predicted the rate decision, with the rest seeing a smaller 50 basis-point increase. Of the five members on the panel, three voted for the 75 basis-point increase, one preferred a 100-basis-point hike and the other 50 basis points. 

“The rand’s reaction is justified by the surprise,” said Cristian Maggio, head of portfolio strategy at TD Securities in London.

The vote split suggests the central bank will maintain its hawkish bias in September “meaning we can already narrow down the range of options to 50 basis points or 75 basis points, leaving 25 basis points and 100 basis points as tail risks in case data comes in particularly weak or strong, respectively,” he said.

Policy makers are acting with urgency to avoid losing their grip on inflation expectations, which the central bank prefers to anchor close to the 4.5% midpoint of its target range. South Africa’s annual inflation rate reached 7.4% in June, the highest level since the global financial crisis.

“Our assessment now is that this inflation risk is no longer transitory, but that there is persistence that is emerging,” Kganyago said. “But that doesn’t mean that inflation is permanent. If the persistence is rising in inflation, you can rest assured the South African Reserve Bank will act, with scale, timeously, to protect the income of South Africans.”

Reserve Bank modeling shows a significant acceleration in headline and core inflation, both of which will only return to close to the target midpoint in the fourth quarter of 2024. Though the outlook may deteriorate further, with power-utility Eskom Holdings SOC Ltd.’s 7% wage increase possibly setting a precedent for other pay negotiations.

The MPC would be concerned about economy-wide wage settlements that are consistently above inflation expectations as that may prompt a wage spiral, Kganyago said.

“Once you have a wage-price spiral, it is going to take even more drastic policy measures from a monetary policy perspective to deal with inflation and we shouldn’t be there,” he said.

The central bank’s preemptive hiking cycle started in November and Thursday’s move helps to narrow the spread between inflation and the benchmark rate, potentially burnishing the appeal of local assets to offshore investors and supporting a currency that’s weakened by more than 6% against the dollar this year.

The higher cost of money adds to the burden of households facing a cost-of-living crisis spurred by rising food and fuel costs, and threatens to weigh on household consumption that accounts for about two-thirds of gross domestic product.

While the move to lift borrowing costs is painful for now, it’s “a sign of a central bank acting credibly to return the inflation rate to their target in order to mitigate the pain of higher inflation down the line,” said Angelika Goliger, chief economist at EY Africa.

The central bank predicts the economy will contract in the second quarter due to flood damage in the province that’s the second-biggest contributor to GDP and deeper, more frequent power outages. Still, it raised its GDP forecast for 2022 to 2% from 1.7%. The slowdown in the economies of key trading partners, including China, and fears of a global recession are risks to the outlook, Kganyago said.


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