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South African Reserve Bank modeling suggests rate increase

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Staff Writer

According to the South African Reserve Bank’s modeling, incremental increases in borrowing costs are required to keep inflation near to the 4.5 percent midpoint of its goal range and long-term interest rates low.

Having been slashed by three percentage points in 2020, the main interest rate is now at a record-low 3.5 percent, thanks to the efforts of the Monetary Policy Committee, which provided an additional 275 basis points of easing to counteract the negative impacts of the Covid-19 pandemic. There has been no additional relaxation by the five members of the MPC since the beginning of this year, and the panel has regularly suggested that the next step will be a rise.

The faster-than-expected economic rebound in the first half of 2021, when output increased 7.5 percent over the same period the previous year, shows that inflation pressures may be stronger than initially anticipated. Price hikes are already hovering around 4.5 percent, which is the level at which the central bank tries to establish expectations. The South African Reserve Bank stated Tuesday in its six-monthly Monetary Policy Review that this, combined with the narrowing of the gap between potential growth and actual expansion, means that the benchmark rate must move toward its neutral level over the medium term in order to reduce stimulus and keep price growth under control, according to the bank.

“Delaying the lift-off could see the monetary policy authorities playing catch-up with inflation, potentially destabilizing the relatively well-anchored inflation expectations.”

It is predicted that the implied policy rate path of the central bank’s quarterly projection model, which is used to inform the MPC’s decisions, will climb by 25 basis points in the last quarter of this year and by 25 basis points in each quarter of the following two years (2022-2203). Forward-rate agreements, which are used to speculate on borrowing costs, are pricing in an almost 100 percent chance of a quarter-point increase at the bank’s November meeting, whereas the majority of economists expect the benchmark rate to remain unchanged until the first quarter of next year, according to forward-rate agreements.

According to economic forecasters, this is in part because of deadly riots, arson, and looting that erupted in July and disrupted economic activity in the country’s two most populous provinces by contribution to gross domestic product, which has continued to contract in the three months through September. According to the central bank, if the disturbance had not occurred, the economy would have recovered the majority of the GDP losses caused by the epidemic last year by the end of 2021.

The bank predicts that the economy will decrease by 1.2 percent in the third quarter and will rise by an average of 5.3 percent in 2021, a significant improvement over last year, when output fell by the highest in nearly three decades, according to the bank. If this results in increased demand, the risks to the inflation forecast could become even more obvious in the future.

However, while South Africa’s modest inflation trajectory has served as a foundation for the MPC’s decisions to keep the key rate on hold since July 2020, risks to the outlook “have increased and become more broad-based, while real rates have become more negative as expected inflation has increased,” according to the reserve bank.

“These developments imply a need for interest rates to begin normalizing. The nominal repo rate is expected to gradually rise toward its neutral level over the medium term,” it said.

According to the central bank’s announcement in July, the domestic neutral rate is computed at approximately 2.1 percent.

According to the report, South Africa’s inflation rate increased for the first time in three months in August, and material upside risks now include elevated global food prices, high administered prices, particularly for water and electricity, and skills shortages, as well as rising global prices and supply constraints, among other things.

However, Governor Lesetja Kganyago has previously stated that this is not the most optimum approach and has recently advocated for a smaller, single-point aim close to 3 percent as an alternative.

Staff Writer

Published by
Staff Writer