High interest rates ‘death by 1,000 cuts’ – but a necessary evil

Investment Specialist at Genera Capital Professor Adrian Saville recently said high interest rates are “the monetary equivalent of death by 1,000 cuts” but are a necessary evil to keep inflation down.

Since November 2021, the South African Reserve Bank (SARB) has been stuck in a hiking cycle. Since this cycle started, the SARB has implemented ten consecutive interest rate hikes, pushing the repo rate to 8.25%.

A cumulative 475 basis points of hikes have been implemented in an attempt to bring the country’s high inflation within the SARB’s target range of 3% to 6% and anchoring it around the 4.5% midpoint.

However, South Africa’s inflation has been sticky and remained well above the upper end of the target for months.

Largely fueled by high food and fuel prices, the country’s inflation kept rising. However, April’s consumer price inflation (CPI) data showed the first sign of hope for relief when it came in at 6.8% – down from 7.1% in March.

This downward trend continued in May’s inflation data, which recorded CPI at 6.3% – slightly below expert expectations.

The US Federal Reserve – which has also been in a hiking cycle and implemented ten consecutive rate hikes – recently decided to pause interest rate hikes.

This, in combination with the cooling inflation rate, makes some experts believe that South Africa could also see a pause in hikes at the upcoming MPC meeting in July.

However, the SARB recently said “higher interest rates for longer” to its Risk and Vulnerability Matrix, which provides a forward-looking assessment of the key risks to financial stability in South Africa over the short, medium and longer term.

SARB Governor Lesetja Kganyago also said, “What is in no doubt is that policy is going to have to remain tight for a little bit longer than the market had been pricing”.

“And the reason has been that inflation has been more persistent than we had actually thought.”

Saville told 702’s The Money Show that interest rates are a “necessary medicine” that South Africa could choose not to take. However, it would come at the cost of stubborn inflation that will, eventually, do even more harm to the country.

The SARB’s interest rate hikes do not seem to be having the desired effect. “If interest rates had the desired or necessary effect, you would have seen inflation tamed,” he said.

“In fact, we’re seeing that this stubborn inflation is a global phenomenon”, as prices have been slow to adjust in South Africa and globally.

In addition, South Africa’s inflation is not caused by monetary factors but rather by the real economy, including choked supply chains, imported inflation, elevated energy prices, and a weak rand. “Interest rates aren’t going to fix those things,” he said.

Saville said this only means interest rates should be used alongside other tools to bring sticky inflation down.

While fears that having high interest rates for longer will harm the economy are understandable, Saville said interest rate hikes remain necessary, and both the SARB and the Fed likely have “a little more ammunition to go”.

San Francisco Federal Reserve Bank President Mary Daly also recently told Reuters that two more US interest rate hikes this year are a “very reasonable” projection.

However, he said that, given how fast rates have risen already and how close they are to where they probably need to be, it’s better to move more slowly and carefully than before.

“It is, in my judgment, prudent policy… to slow the pace of policy as you near the destination,” he said.