Interest rate expectations this week

The South African Reserve Bank’s Monetary Policy Committee will decide on interest rates this week. I think it will be a very close call, and I expect a split decision. However, it would be an oversimplification to simply expect a rate hike – a rate hike is not a done deal.

Arguments for a rate hike

While we have the very high oil prices, which will lead to substantial further petrol price increases from October, we have also seen a series of central banks hiking rates over the last few weeks. In addition, we are moving closer to the situation the Reserve Bank referred to at the July MPC – where high oil prices remained elevated for a relatively extended period, which in that scenario would have justified another rate hike. Oil prices are now materially higher than just before the July meeting, and the Bank’s inflation forecast will likely be lifted.

Headline inflation will also move higher. I expect the August number, due this week, to rise from 4.3%, probably to around 4.5% to 4.6%, and likely above 5% in October and November. However, the August number itself should have very little impact on this week’s decision, as it comes out only a day before the MPC announcement. The Reserve Bank’s forecasting models and analysis are effectively completed well before the meeting. This was also the case in July, when the inflation number came out at 5%, but the Reserve Bank did not react to that number because its forecasting process had already been completed.

Arguments for keeping rates unchanged

On the other side, we have the very stable rand exchange rate, despite all the uncertainty around the war. Real interest rates are still relatively restrictive, while inflation expectations in the third quarter came down from the second quarter. In particular, household and trade union inflation expectations have dipped quite a bit – contrary to fears that these would have lifted further.

However, perhaps the strongest argument for keeping rates unchanged is that the Reserve Bank already hiked in May. The argument at the time was to hike early, rather than wait until much later and potentially have to hike more aggressively. The Bank has therefore already moved ahead of many other central banks, including the Fed, which only hiked for the first time this past week.

The question now is whether it makes sense to hike again so soon, before we have seen the full impact of that May hike working through the economy – especially since inflation expectations actually eased in Q3. I think there is a strong argument for waiting and seeing what the May hike does, particularly given the stable rand and lower inflation expectations.

Wage settlements in the second quarter were unchanged from the first quarter. Importantly, we have not seen clear second-round inflationary effects from the petrol price increases. They have flowed through into transport costs, airline fares, taxi fares, bus fares, etc., but not into other prices.

In addition, the fact that other central banks have hiked, has relatively limited impact on the Reserve Bank in this particular situation. I don’t see a clear carry-trade impact on the rand. If the Reserve Bank was starting an extended rate-cutting cycle while the US and other global central banks were hiking, that would be different. However, one or two rate moves in the opposite direction are unlikely to have much impact. There is also a broader argument that oil price shocks like this can be deflationary in nature. Higher transport and energy costs reduce spending by both consumers and businesses, which means slightly weaker economic growth. For consumers, spending more on petrol and transport also means less spending elsewhere. That substitution effect dampens demand and therefore limits other price increases.

So, while headline inflation will move higher, I don’t think that in itself changes the picture.

Bottom line

While there are arguments for a rate hike, looking at the balance of what is happening, I still believe there is a strong argument for keeping rates unchanged.

It will be a very close and probably split decision. I still caution on the side of no rate hike at this meeting.