Predictions versus Outcome on the Interest Rate Hike

Lesetja Kganyago Reserve Ban Policy Meeting January 2016

The rand recently tested a new low against the dollar, leading experts to predict a drastic inflation rate in the near future.  Inflation was expected to reach its highest since 2012, which many thought would lead the central bank to adopt more aggressive policies in order to rectify the issue.

South Africa’s break-even rate –which is a representation of the inflation expectations of bond investors – is now at five years.  After the rand fell to around 18 units per dollar early this year, the break-even rate rose 7.45 percent to 21 basis points.

The gravity of the rand’s current situation is highlighted when the South African economy is compared with that of Turkey.  An emerging market with similar features, Turkey’s break-even rate has declined six points in the recent financial environment.

This doesn’t bode well for the rand, as it makes sense that the economy is inversely proportionate to inflation.  As the rand weakens, the inflation profile will rise.  Early in the month experts predicted that the upcoming interest rate increase would see a rise of as much as 50 basis points.

Talk of the Interest Rate Hike

The interest rate experienced a similar hike two years ago, when the Reserve Bank raised interest rates by 50 basis points in January of 2014.  Since then, the hikes have not been so dramatic.  On three occasions since that hike, interest rates have been limited to quarter-point increases – the most recent of these being in November of last year, when the repurchase rate moved to 6.25 percent.

The target range for inflation in the first and fourth quarters this year is between 3 and 6 percent.  Inflation moved to 4.8 percent in November of last year.

Reserve Bank Raises Interest Rate

The inflation rate breaking its intended limits is something traders seemed fairly certain of.  They were betting that the Reserve Bank would raise rates by more than 25 basis points during its policy meeting at the end of January.  As it turns out they were right.

The Reserve Bank decided on a 50 basis point increase, worried about the weak rand’s effect on the overall economy.  The interest rate was raised to 6.75 percent, in line with many economists’ predictions.  This aggressive action was forced by the fact that, since the last policy meeting, the rand had dropped 15 percent against the dollar.

This rate hike increases the risk of recession, and the chance of GDP contracting for two consecutive quarters is now 45 percent.  With conditions like these, the future looks very uncertain indeed.

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