Johannesburg - South Africans should expect more shocks to their finances as the Reserve Bank is poised to raise interest rates further to stem inflation.
This prediction was made yesterday by Citi Research, which said the bank’s monetary policy committee (MPC) would raise interest rates twice more by July despite the view held by many economists that this would happen only in the second half of this year.
Citi said that the MPC was likely to raise interest rates by at least 150 basis points to dampen domestic demand and inflation but said the economy was likely to suffer as a result.
This statement follows last week’s 50 basis point rate hike, the first in almost five years.
In a paper titled “The Monetary Policy Transmission Mechanism”, Citi said it expected the MPC to hike twice more, by 50 basis points in both March and July.
Other economists agreed, although not on the extent.
The prediction is shared by Iraj Abedian, the chief economist at Pan African Investment and Research. “I agree with Citi’s forecast because the Reserve Bank has got itself into a position where it has to continue hiking rates. It is a wrong policy. It was peer pressure and poor logic. The foreign exchange market is not responding.”
The inflation rate averaged 5.7 percent last year. The Reserve Bank forecasts an average inflation rate of 6.3 percent this year. It sees inflation peaking at 6.6 percent by year end after breaching the upper end of its 3 percent to 6 percent target in the second quarter.
Citi Research, a division of Citigroup Global Markets, said that while 150 basis points in hikes was manageable, more would damage the economy.
It said though company earnings had been rising more recently, they still remained lower than in the lead-up to every hiking cycle except 2002.
It said: “With potential rate hikes adding to an already long list of local costs and challenges to production, corporate earnings are likely to decelerate from here if a cumulative 150 basis points in hikes occurs this year, as we are forecasting.
“This would discourage the take-up of corporate credit and would then likely weigh down on private sector investment, which is already lower than all previous cycles barring 1998.”
However, Dawie Roodt, the chief economist at Efficient Group, said rates had to rise by 200 basis points in all to curb inflation. He said: “Even 50 basis points was a bit low. We need an increase of between 50 and 100 basis points. The rand remains under pressure.”
The rand has fallen more than 20 percent against the dollar since the start of last year and by about 7 percent this year.
Citi said the theory stated that, as interest rates rose, the cost of credit increased, which discouraged the take-up of new credit while concurrently raising the cost of existing credit. This lowered growth, which led to lower inflation.
Citi said: “A critical question for the credit channel is whether it has been effective in lowering inflation in the face of rate hikes. History suggests so, as all hiking cycles have been followed by slower consumption growth and lower consumer price index [growth], with a simultaneous lowering in core inflation.”
Another critical question was whether this had ever been overly detrimental to growth.
“We only find one instance of this in the onset of the 1998 Asian crisis when the Reserve Bank used forex reserves and rate hikes to defend the depreciating currency, hiking rates 700 basis points in three months.
“Though inflation slowed rapidly (from 9.2 percent year-on-year in the fourth quarter of 1998 to 1.9 percent in the fourth quarter of 1999), gross domestic product growth hit a low of 0.1 percent year-on-year in the second quarter of 1998.”
It said that, in contrast to low household credit, consumption had actually been performing fairly in line with its historical trends ahead of the hiking cycle figures. The only exception was the lead-up to the 2006 to 2008 hiking cycle where consumption was unusually robust. However, this was also an exceptional period of robust credit extension.
Citi said: “Interestingly, a split of household consumption into non-discretionary (services and non-durables) and discretionary (durables and semi-durables) spending shows that while non-discretionary spending has struggled in the lead-up to the January rate hike, discretionary consumption has actually proved stronger than usual. Again the only exception here was the credit-fuelled 2006 to 2008 era.”
Johann Els, the senior economist at Old Mutual Investment Group SA, expected increases of 50 basis points at the next two MPC meetings.
He noted that Gill Marcus, the Reserve Bank governor, said after last week’s MPC meeting that any rate increase would depend on the latest available data. - Business Report