Forex Investment and Currency Trading

Mboweni’s comments

‘It doesn’t take a genius to know that rates are going up’. These comments by SARB Governor Tito Mboweni a few days ago, together with the admission that he had spoken to his MPC colleagues about the possibility of a 200 bps rate hike, triggered a sharp selloff in South African interest rate markets. Combined with the release of worse than expected inflation data for April (CPIX at 10.4% y/y), this sealed the case for a further interest rate hike in June. Despite the fact that the SARB had until then expressed a clear preference for gradual tightening, moving only 50 bps at a time, the market started to price in a full 100 bps for the June 12th interest rate decision.

Assessment of inflation risk appears to have changed

Initially of course, it was difficult to know what to make of Mboweni’s 200 bps comments. His prepared speech at the time (‘Central Banks in times of turmoil’) was about financial stability and not especially focused on the inflation target or the extent of interest rate tightening required. The issue came up during a Q&A session. Moreover, warning that a 200 bps rate hike was possible (qualified later by the statement that ‘anything is possible’), did not mean that a 200 bps rate hike was probable. Despite a relatively benign April MPC statement however, there has been a distinct ratcheting up of the hawkish rhetoric, with Governor Mboweni even speaking at one point about the need for an intermeeting interest rate move. Something has apparently changed in the SARB’s assessment of inflation risks. In the last week alone, at least 3 of the SARB’s MPC members (Tito Mboweni, Monde Mnyande and Brian Kahn) have warned of the possibility that inflation will not return to target until the end of 2009, and that there are considerable upside risks to this forecast.

…and growth is weak…

Even so, for many, recent weakness in the economy casts some doubt on the extent to which the SARB can tighten monetary policy aggressively. It is now more clear that earlier interest rate tightening is starting to have an effect on the real economy (in view of the typical lag with which monetary policy changes operate, and the start of the tightening cycle in June 06, this if of little surprise). The slowdown is especially apparent in the interest rate sensitive sectors of the economy. The latest print for New Vehicle Sales declined over 23% y/y (although it is worth noting that demand for commercial vehicles appears to be holding up – for now at least). Non-Performing Loans have started to rise sharply, albeit from negligible levels, and total NPLs remain very low. Property prices have stopped rising as rapidly as they had done in recent years.
But while the interest-rate sensitive sectors of the economy are exhibiting signs of a slowdown, there is still some momentum to growth.

Perception and reality

There is now an even more stark difference between perceptions of growth, and the economy’s underlying performance. Part of the problem is that much of the contemporaneous data that is available (which is looked at to assess the performance of the economy) tends to be derived either from sentiment surveys, which are not themselves robust indicators of underlying growth, or from interest-rate sensitive sectors, which in an environment of monetary tightening, may exaggerate the true extent of economic weakness. One would expect, for example, that New Vehicle Sales should be closely correlated with the extent of credit available and the price of credit. But while the headline number is contracting, some of its subcomponents, such as sales of commercial vehicles, have been holding up. The same is true of the credit extension data, which finally dipped below the 20% y/y level in April. The subcomponents of PSCE, rather than just the headline, tell the whole story. Why does this matter for interest rates? Because in formulating monetary policy and the future risks to inflation, the SARB will need to examine the actual performance of the economy, rather than just the common perceptions of it. South Africa’s economy may still be doing better than we think. For now, at least.

But this still leaves the tough question – how much must interest rates increase?

There is little debate that interest rates have to rise further. The question is, how much of a tightening should we expect at next week’s June MPC meeting, and it is on this matter that we admit to being a little bit stumped. There is certainly an argument for 50bps. The Reserve Bank is comfortable with the gradual pace of tightening. Given that there is some uncertainty over future growth, this allows the SARB the time to monitor new data between meetings, and prevents any unnecessary overshoot of interest rates. But there are also important counter-arguments in favour of a 100 bps hike. First – inflation is accelerating, and that means in real terms, policy will become more accommodative, if the pace of tightening does not pick up. In view of the risks to inflation, with clear evidence of a secondary impact, and even true core measures of inflation now above the target, more accommodative policy may not be appropriate. Second – the SARB now see CPIX above its target for a longer time period, at least another 18 months. They are no longer only reacting to the near term spike in inflation, against which the efficacy of interest rate tightening might be questionable. Prolonged inflation risks create a stronger argument for decisive monetary tightening. Third, the chorus of SARB MPC comments about inflation risks – when the market was already pricing in 100bps – should not be ignored. SARB speakers would have had ample opportunity to offer guidance to the market, if the market was calling it wrong. They did not, and this is significant. (The speech of the Chief Economist, Dr Monde Mnyande, even went so far at to recount what the FRA market was pricing in – the repo at 13% eventually). The risks to the ZAR (and therefore imported inflation), should market expectations for an aggressive tightening be disappointed, will not be lost on the SARB.

It’s a tough call, and the risks are finely balanced, but given all of these factors, a 100 bps rate hike next week now looks more probable than not.