Marcus retains credibility by not cavingComment on this story
South Africa’s first interest rate increase in five years is persuading traders that central bank governor Gill Marcus will be unmoved by slowing economic growth and rising political pressure in her quest to conquer inflation.
Forward-rate agreements (FRAs), used to lock in borrowing costs, are signalling a further 240 basis points of rate increases over the next year. Similar contracts in Turkey, whose central bank also raised rates last week, show another 24 basis points. The difference in yield between two- and 12-year rand securities shrank 27 basis points since Marcus unexpectedly lifted the Reserve Bank’s policy rate by half a percentage point to 5.5 percent last week.
With elections looming and the economy struggling to recover from the slowest growth since the 2009 recession, Marcus was facing pressure from the ANC’s labour union allies to keep borrowing costs at a three-decade low.
Instead, she reiterated that the central bank’s primary role was to ensure price stability as the rand’s swoon this year has sent inflation toward the upper end of her 3 percent to 6 percent target band.
“It has done the bank’s credibility a lot of good,” Rian le Roux, the chief economist at Old Mutual Investment Group South Africa, said on Friday. “It demonstrated that if inflation pressures build they will take their eyes off weak growth and focus on the inflation target. History tells you they won’t only hike once.”
With one exception, every rate increase by the Reserve Bank since 1998, when Bloomberg started compiling the data, signalled the start of a tightening cycle. The anomaly was in October 2000, when then-governor Tito Mboweni lifted the repo rate by 25 basis points and then cut it by 100 basis points the next June.
FRAs starting in 12 months soared 103 basis points after the rate increase to 8.09 percent on Friday, the highest level since November 2008 on a closing basis. The three-month Johannesburg interbank agreed rate is 5.68 percent.
The bank had kept its repo rate steady since a surprise 50 basis point cut in July 2012 to support an economy buffeted by slower global demand and mining strikes. Those concerns are being overshadowed by a weaker rand, which is raising the cost of imports such as oil and food.
Inflation accelerated in December for the first time in four months, to 5.4 percent. The rate would probably breach the upper end of the target in the second quarter, and average 6.3 percent this year, Marcus said last week. That’s up from a previous estimate of 5.7 percent.
Turkey’s central bank unexpectedly raised its one-week repurchase rate last week by 5.5 percentage points to 10 percent. India also surprised by increasing its key rate to 8 percent from 7.75 percent, while Brazil has boosted rates for six consecutive meetings.
South Africa’s rate increase was not aimed at supporting the rand, though the currency’s weakness was the primary risk to inflation, Marcus said.
According to the bank’s model, the inflation rate should rise 2 basis points for every 1 percent drop in the rand. The pass-through had been more muted than that due to weak economic growth, she said.
The central bank cut its economic growth forecast for this year to 2.8 percent from 3 percent. The forecast for next year was reduced to 3.3 percent from 3.4 percent.
While growth was a concern, “the primary responsibility of the bank is to keep inflation under control and ensure that inflation expectations remain well anchored”, Marcus said.
The rand has slumped amid a sell-off in bonds sparked by the US Federal Reserve’s tapering of stimulus. Foreign investors have dumped a net R21 billion worth of South African bonds this year after annual inflows in the previous five years.
The nation needs about R19bn of foreign investment a month to finance its current account deficit, which swelled to 6.8 percent of gross domestic product in the third quarter.
While the central bank did not directly target the level of the rand, raising interest rates at a time when the currency was weakening created a perception it had shifted focus, Gina Schoeman, an economist at Citigroup, said.
Higher borrowing costs might be ineffective in slowing price increases, she said.
“They have changed their tune,” Schoeman said on Friday. “They have always been a bank that targets inflation expectations, but now they are far more cognisant of the currency.”
President Jacob Zuma has to call a general election before the end of July. With the ruling ANC’s support waning amid voter disenchantment because of 25 percent unemployment and a series of corruption scandals, the risk of a “populist backlash” that would trigger another round of credit rating cuts was rising, Schoeman said in a note on January 16.
Cosatu has said it opposed inflation targeting and has called for a weaker rand and lower rates to stimulate growth.
Last week’s rate increase showed Marcus would not cave in to populist pressures, Peter Attard Montalto, an emerging markets economist at Nomura International in London, said. – Bloomberg