South Africa's future rate increases will inevitably begin to corrode consumer spending and disposable income, says Parsons

By Professor Raymond Parsons, NWU Business School

Prof. Raymond Parsons, NWU Business School

The South African Reserve Bank (SARB) raised its main lending rate by 25 basis points yesterday, in a decision that was in line with analysts forecasts. The SARB cited risks to the inflation outlook from the war in Ukraine among reasons for its decision to increase the repo rate to 4.25%.

Given the overall balance of economic risks currently facing South Africa, the Monetary Policy Committee’s (MPC) judgement that a 25 basis points rise should suffice for now is right. However, the tone and language of the MPC statement was distinctly ‘hawkish’.

Three members of the MPC preferred the announced increase while two members preferred a 50 basis point rise in the repo rate. The divided vote of 3-2 on the MPC reflects its broad concern that current supply-side shocks will lead to prices acquiring a momentum of their own and thus need an appropriate response from monetary policy now.

The MPC statement recognises that the Russia-Ukraine war has injected a significant new dimension of uncertainty into monetary policy and economic forecasts. The MPC statement confirms that there are now indeed new upside risks to inflation, especially in energy and food prices. Much will, of course, depend on the duration of the supply shocks and how long the Russia-Ukraine conflict lasts. Fuel and food costs are nevertheless expected to significantly rise further during the course of the year.

“The Bank’s forecast of headline inflation for this year is revised higher to 5.8% (from 4.9%), primarily due to the higher food and fuel prices. While food prices will stay high, fuel price inflation should ease in 2023, helping headline inflation to fall to 4.6%, despite rising core inflation,” said SARB Governor, Lesetja Kganyago.

“Core inflation is forecast to increase to 4.2% in 2022 (up from 3.8%), to 5.0% in 2023 (from 4.4%), before easing somewhat to 4.7% in 2024 (from 4.5%). Core goods and services price inflation is forecast higher throughout the horizon, and services price inflation exceeds the mid-point of the target by the fourth quarter of this year.”

The latest MPC decision is the third successive increase since the SARB began its interest-raising cycle in November 2021 to deal with a deteriorating inflation outlook. A cumulative rise in borrowing costs of 75 basis points since last November, together with likely future rate increases, will inevitably begin to corrode consumer spending and disposable income. Higher fuel prices will also cause slower growth.

The MPC’s revised and better growth forecasts for 2022 may therefore be on the optimistic side. The jury is still out on whether these improved growth expectations will be realised. And if future interest rate rises are too aggressive, the risk of stagflation will increase. A difficult balance has to be kept. Looking ahead, core inflation and wage growth are the key indicators the MPC is likely to watch in deciding the pace of further rate hikes.

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