File photo: Reuters

South Africa is now officially at the start of a gradual rate tightening cycle that may last three to four years, according to Paul Stewart, the head of asset management at Grindrod Asset Management.

Following the Reserve Bank’s announcement yesterday that its repo rate would be increased by 50 basis points, he said interest rates might rise by 150 to 200 basis points.

He had expected the repo rate to remain at 5 percent for the bulk of this year.

Stewart suggested that the decision by several emerging market central banks to aggressively hike their short-term rates could have forced the hand of the Reserve Bank’s monetary policy committee (MPC). “They had to be seen to be doing something instead of standing by and watching the train wreck.”

He noted that in many emerging markets “a significant proportion of their bond debt is issued in dollars and euro, so currency depreciation implies much higher interest costs to the fiscus and the rate hikes are an attempt to stem the capital outflow. But this is not the case in South Africa where the bulk of the debt is rand denominated.”

While this left the bank with room to manoeuvre, it had elected not to use it, Stewart commented. He predicted the hike would not have much of an impact on the economy or hit consumers too hard. But further rate hikes would build the pressure.

Nomura strategist Peter Attard Montalto had a similar take: “We see today’s hike as the start of a 200 to 250 [basis points] hiking cycle that should be completed by the middle of 2015 and now see another two hikes this year, most likely in the second half.

“This move considerably increases the MPC’s credibility in our view; many thought it would not adhere to its mandate and would be overly political. This move suggests that the MPC is indeed orthodox and conservative.”

John Loos, the household strategist at FNB, said the decision could not have been taken lightly, in view of the low growth outlook.

“But at the end of the day the bank does have an official 3 percent to 6 percent inflation target, and must be seen to be responding to severe inflationary pressures should it wish to maintain credibility.”

Razia Khan, the head of Africa research at Standard Chartered, highlighted the extent of deterioration in the bank’s inflation forecast. “Although there has been limited evidence of pass-through from rand weakness to the consumer price index [CPI] to date, the bank remains concerned about the impact of further rand weakness.

“It now forecasts that inflation will average 6.3 percent this year, peaking at 6.6 percent by the end of 2014. This is up from the 5.7 percent average inflation it had forecast at its last MPC meeting in November. In our view, despite the limited evidence of inflation pass-through to date, tightening by other emerging market central banks will have raised pressure on the bank to act.”

Absa Capital economist Peter Worthington said the market had “become increasingly aggressive in pricing in hikes over recent weeks as the rand depreciated and as other similarly vulnerable emerging markets tightened further”.

He said just prior to the meeting forward-rate agreements were pricing in a 60 percent probability of a 50 basis point hike at this week’s meeting.

“The market has become even more aggressive in pricing in rate hikes in the wake of the MPC’s decision, given that the decision has confirmed that the bank is indeed prepared to hike rates if warranted.” – Business Report