TV Interview with SABC about Today’s Interest Rate Decision

I spoke to Francis Herd on SABC News’ Business Review last night at 8pm about the upcoming interest rate decision today.

The Reserve Bank’s in a tight spot. If they don’t raise interest rates, the rand weakens further (because the market’s pricing around 3 percentage points worth of hikes in the next year), and fuels inflation of particularly staple foodstuffs that impact low income earners and the unemployed, and we get more labour unrest and higher wage demands.

Either way, the economy is in for some tough times. It’s now up to the Reserve Bank to decide how they’re going to distribute gains and losses between different segments of society in the short-term. In the past three years they’ve implemented policy that favoured middle to high income people who take on secured debt (the wealthy), let’s see if they decide to switch in favour of supporting pensioners, low income earners, and the unemployed for a change by raising short-term interest rates further and purging the accelerating price inflation out of the economy.

It’s anybody’s guess, really. I’m of the view they should surprise economists again by hiking today, but I doubt they’ll do this. So most likely we see an unchanged decision. YouTube of the interview follows the link below.

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South Africa Interest Rate Outlook

Economists and the market now anticipate that the Reserve Bank will hike the repo rate this week, and if not this week, in the next three months. In June 2013 my colleague George Glynos and I outlined ETM Analytics’ interest rate outlook. We wrote that: “Baseline view that repo is hiked 50bp and in the event of a ZAR closer to 11.0000/dlr possibly a second 50bp hike in a short-lived hiking cycle, with rate cuts recommencing perhaps 6-12 months after hikes. In other words, 12-18 months from now repo could easily be 5.00% but with rate hikes and cuts between now and then.” We got quite a bit of flack from the market back in June for putting out this view that rate hikes are on the cards, but it’s nice to see the market has come around to this view now. Download the full report after the link.

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The Retail Boom in SA

I’ve written about the consumer and retail boom in South Africa many times in recent years – most recently in “SA Mining at ‘Breaking Point'”, “South Africa’s Regressing Economy”, and “Impact of Real Interest Rates on Retail and Manufacturing.”

Retail spending is being funded mostly by borrowing from foreigners and locals selling assets to foreigners. We’re selling our capital stock to foreigners and spending the proceeds, not reinvesting it in manufacturing and productive capacity. A low-real interest rate environment means SA is living beyond its means. It’s a highly bearish long-term development for the SA economy.

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How to prevent saving

Since September 2010, nominal interest rates in South Africa have been at historic, more than 35 year, lows. Real interest rates in South Africa have also now been negative for more than a year now. (This means that the annual CPI inflation rate exceeds the SARB’s repo-rate.)

The SARB’s maintenance of negative real interest rates is inevitably leading to serious distortions in the economy’s capital structure, as excessively short-term projects and unsustainably long-term capital projects become more common. This sets the scene for future economic turbulence as the market will have to correct the misallocations of capital that are taking place now.

At the moment, artificially low interest rates are common in most of the large economies of the world. With these rates, central banks are trying to encourage borrowing and spending and, by extension, discourage saving.

It is therefore quite ironic that the minister of finance, Pravin Gordhan, in his department’s budget speech earlier this week, called for constraints on lending and increased savings in South Africa, when current government monetary stance is actually one of the main drivers of increased credit extension in South Africa.

The last period of interest rate decreases, from 2003 to 2006, encouraged exactly this type of imprudent take-up of credit. As you can see on the graph, the household debt-to-income ratio increased from around 50% to 70% during that time, and continued to rise to over 80% despite the rate hikes from 2006 to 2008. The current low interest rate environment is maintaining those high debt levels, but sets borrowers (and/or lenders) up for a painful unwinding of that position when future rate hikes become unavoidable.

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Real monetary space up strongly, market likely to start talking rate hikes soon

The Companies and Markets front page in the Business Day this morning suggests the economy is in the early stages of an upswing phase, with corporate revenue growth, profits, and M&A activity healthy. “ARM earnings to rise”, “Curro buys schools”, “Metrofile revenue up”, “Trencor profit rises”, “Sycom raises cash”, “Basil Read expects ‘bumper year'”, “Imlats sees platinum deficit as demand rises”, reads more than half the headlines on the page.

The real monetary space in the economy has spiked in recent months. This simply means that new money supply is flowing into the economy at a much faster rate than consumer or producer prices are rising, creating a real increase of money supply. This is what is driving the increase of economic activity at present, as reflected in the strong topside surprise of retail sales in December. Wholesale trade sales at constant prices grew at a rate of 6.1% y/y in December, up from 5.8% in November, data released by StatsSA showed yesterday, also confirming this view.

As we have maintained for a while, we are in a flat for longer rate environment. However, looking forward, the pick-up of economic activity holds implications for price inflation. CPI inflation will be likely to rise in line with the SARB’s forecast, but that said, growth will be likely to come in higher than the SARB’s forecast. This will tend to keep rate expectations climbing going into the third quarter of the year.

This is an extract from ETM Real-Time morning market commentary, written by Chris Becker. To subscribe and get more in-depth analysis, contact me.