MPC rate hike

The South African Reserve Bank (SARB) has increased the repo rate by 25 basis-points (bps), from 3.50% to 3.75%. Members of the Monetary Policy Committee (MPC) voted 3-2, split between a rate hike and an unchanged stance. Although the committee said that the rate hike cycle will be “gradual”, we believe that this rate hike increases the probability of further rate hikes in the near term. We agree with the bank that the hiking cycle should be gradual, and as such we do not believe that a 25bps rate hike implied by the SARB’s Quarterly Projection Model (QPM) at each MPC meeting over the next 2 years is desirable nor sustainable in an economy that is likely to remain fragile with muted demand-pull inflation pressures. 

The rate path projection of the QPM currently provides a guidance of eight 0.25% rate hikes over the next 2-years, which if correct, will result in a cumulative rate hike of 2%. The SARB has mainly attributed this trajectory on second-round effects, primarily driven by administered prices, fuel costs, and nominal wages rising well above headline inflation. 

Granted, the SARB mandate is centered on inflation forecast targeting but we remain very concerned about the downside growth risks, with many activity indicators already disappointing. Furthermore, if one takes into account the electricity shortages as well as logistical challenges, this will continue to weigh on the post-pandemic gradual recovery and result in more depressed levels of fixed investment and employment and ultimately lower domestic demand. South Africa is simply not an economy that can absorb 2% cumulative interest rate hike over the next 2 years. We expect weak domestic demand to contain inflation and are at this stage less concerned than the SARB about second-round inflation risks. 

Again, when looking beyond the low base economic rebound, which was further induced by widespread COVID-19 inoculation programs, South Africa’s economic activity remains constrained with benign investment spending, a narrowing current account surplus, as well as stubbornly elevated levels of unemployment. According to our research and yesterday’s MPC statement, a 25 basis-point increase in the repo rate tends to undermine economic growth by 10 bps on average. Therefore, we see the SARB embarking on a slow and gradual hiking cycle as they have indicated, in the interest of sustainable economic recovery and in the absence of significant inflation pressures.

The Nedgroup Cash Solutions’ range of funds were all very well positioned for this rate hike, as we only hold floating rate instruments which will all reset their interest rate coupons to the new higher rate within the next few weeks and months.  This will be welcome relief for income investors from the large rate cuts implemented in 2020 and we will therefore maintain this strategy throughout the expected rate hiking cycle.

Taquanta Asset Managers