Forex Investment and Currency Trading

The SARB Monetary Policy Committee raised interest rates today by 50 bps, in line with the expectation. Although the difficulty of the decision was played down by SARB Governor Tito Mboweni during the press conference that followed (he claimed that every monetary policy decision since 1999 had been difficult – a marked contrast to his comments at the time of the last MPC meeting in Jan when he quipped that it had taken all of 5 minutes to decide to keep interest rates on hold), it is clear that this meeting was a tough call.

Analysts were divided over the prospect of a rate move and the market had not been fully pricing it in. Also revealing was the suggestion that there had been considerable debate amongst MPC members about the decision, and that the discussion may have centred – for the very first time in this cycle – on whether to raise interest rates by 25 or 50 bps. Clearly, there is much uncertainty ahead. High frequency, more contemporaneous data and a slew of different surveys all point to a slowdown in the economy – in the near term at least, but all the risks to inflation are firmly tilted to the upside. To predict the course of South African interest rates accurately, it is necessary to appreciate the weight that the SARB is likely to assign to different factors.

First, on the controversial matter of the ‘explanation clause’ – which has now replaced the ‘escape clause’ as a possible fallback when breaches of the inflation target are due to factors beyond the control of the Reserve Bank. Comments by SARB Governor Tito Mboweni made it clear that this would only be seen as a last resort option, if that. (An explanation clause? ‘You cannot run away at the first sign of difficulties’). Despite the nature of inflation, with food and fuel prices considerable sources of stress, the SARB remains committed to bringing CPIX inflation back within the target range.
Given the view that inflation is likely to remain above 8% for all of this year, it would be wrong – at any point over the course of 2008 – to safely assume that the SARB are done tightening, even though the core call is that the April rate hike probably signals the last of the tightening cycle. The SARB will be vigilant about any sign of further deterioration in the inflation outlook, and markets will need to pay attention to this.

Deteriorating expectations… There is little doubt that inflation expectations – what the SARB hope to be able to anchor – have deteriorated meaningfully. The latest BER survey demonstrates this, with average inflation expectations remaining above the 3-6% target range for the entire forecast horizon of the survey. According to the BER survey, inflation in 2008 is expected to average 7.8% (from 5.9% previously), 7% in 2009 and 6.7% in 2010. Also revealing is the breakdown between survey participants. While financial analysts expect inflation to moderate relatively quickly; business executives and trade unions expect it to stay above target for a prolonged period. It is the expectations of the latter groups that matter more for actual price setting decisions in the economy. As the SARB MPC statement itself puts it, ‘The trend of wage settlements is a critical variable in determining whether inflation expectations do in fact translate into higher inflation’. The raising of the repo by 50 bps this April may well have been in reaction to this marked deterioration in inflation expectations.

…and a power crisis to add to the fun

Great uncertainty still revolves around the issue of electricity prices. As a result of the current power crisis, with the temptation to attribute at least some of the difficulties to the traditional low cost of electricity in South Africa, the state-run electricity company has requested a 53% tariff increase from the National Energy Regulator. This is likely to be decided on in June. If granted – and this is something that the SARB itself cannot be sure of at this point – then trying to forecast when inflation returns to target in any sort of meaningful way becomes an almost impossible task. Inflation would spike at a higher level than we currently anticipate, and it would be more drawn out, and it would require an even greater effort on the part of the SARB to try to restore some price stability. The structural change that the South African economy continues to undergo, with the emergence of a new middle class possibly influencing the economy’s traditional cycle, only complicates things further.

Let us look at the evidence before the SARB. All indications are that household consumption expenditure has responded to the tighter monetary stance already in place. Private sector credit extension, amazingly buoyant throughout the recent economic upturn, is finally showing some signs of moderation. The growth rate of real final consumption expenditure declined consistently over the course of 2007, growing at an annualised rate of ‘only’ 3.8% in Q4. But against this trend of slowing consumption expenditure, there is still a sufficiently robust infrastructure spending program that could yet provide more support to the economy than many anticipate.

On a recent visit to South Africa, there were still lots of building cranes everywhere. And – come to think of it – lots of lights still switched on, despite the debate on electricity pricing that rages in the background. this will be the last of the rate hikes. But upside risks to inflation persist, and any adjustment to electricity tariffs in particular may be sufficient grounds for a future rethink.