SARB MPC raises repo rate to 4%
SARB decision lays a path to transition from emergency measures
JACQUES CILLIERS and MAMELLO MATIKINCA-NGWENYA
THE SOUTH African Reserve Bank’s decision to adjust rates is a sign of recovery in the underlying economic activity, with the mitigation of inflationary pressure by normalising interest rates providing South Africa with a path to transition from the emergency measures implemented over the last two years.
Furthermore, normal operating conditions will be conducive to broad-based economic recovery that will also benefit sectors that are disproportionately impacted by the pandemic.
Our country needs to take deliberate steps towards full recovery after two years of remarkable resilience. We’re certainly encouraged by the enthusiasm of our retail and commercial clients to unlock growth opportunities.
The decision by the Reserve Bank to increase the repo rate by 25 basis points was in line with our (and consensus) expectations.
Certainly, recent inflation outcomes and inflationary risks on the horison justify a gradual hiking cycle that should ensure persistently anchored inflation expectations around the Bank’s preferred 4.5% midpoint, while concurrently not choking the ongoing fragile cyclical economic recovery.
With the economy generally expected to revert to the pre-pandemic 2019 4th quarter level in the near-term, and expectations of modest global monetary policy tightening, the SARB could adjust interest rates faster in order to prevent the de-anchoring of inflation expectations, which would be costly to the economy over time.
Nevertheless, in this hiking cycle, we expect the Reserve Bank to proceed with caution amid the significant slack in the labour market. We are pencilling in two more 25 basis point hikes in the first half of 2022, which would put the repo rate at 4.50% by the end of the year.
At the moment, the risks are biased towards more hikes than we currently expect amid several inflationary risk factors that could keep inflation uncomfortably close to the 6% upper band of the 3-6% inflation target range.
The prime lending rate will increase to 7.5% as a consequence of the Reserve Bank’s announcement.
Jacques Cilliers is the chief executive officer at FNB.
Mamello Matikinca-Ngwenya is FNB’s chief economist.
What does the repo rate have to do with stock market investments?
WITH THIS section of Personal Finance being devoted to providing insights into stock market investments, you are probably wondering what the recent announcement of a hike in the SARB repo rate has to do with stock market investments.
In fact, interest rate movements are a lot more relevant to equities than one may think.
Traditionally, there is an inverse relationship between interest rates and stock market returns—in other words, when interest rates rise, stock market returns tend to go lower (and vice-versa). This is due to a number of reasons:
- If a company is carrying a lot of debt, interest rate hikes result in an increase to the cost of borrowings. A higher interest bill equals lower profits, with the share price therefore responding negatively.
- There is a fine balancing act between risk and returns. When interest rates are low, this affects the rate of return on cash. Interest paid on bank balances in a low-interest environment is often lower than the inflation rate, which means that in real terms one actually loses money by keeping it in a savings account. However, as rates rise, investors may be tempted to pull their funds out of the comparatively riskier equity instrument and move them into the relatively ‘safer’ savings account.
However, this is a rather simple view, and other factors come into play.
For instance, South Africa is part of a greater global economy, so local interest rate movements need to be compared to what is happening internationally. If South Africa raises interest rates faster than elsewhere in the world, international investors may look to investing their cash in South Africa in the search for yield.
This would cause the rand to strengthen relative to other currencies, which is positive for South African companies that are heavily reliant on imports. A stronger rand means lower costs for such companies, thus translating into higher profits. Share prices for such companies are thus likely to respond positively.
Of course, the converse is true for companies that have a lot of exports, since a strengthening local currency means that the company receives fewer rands for the goods that it sells—and if its costs are local, profits will decline. This is likely to depress the share price.
The market could also interpret interest rate hikes as a positive move aimed at keeping inflation under control. Hiking rates may also be an expression of confidence that the economy is fairly robust. However, if the pendulum swings too far and rates rise too quickly this could end up weakening the economy. Price hikes to cover rising interest bills may also end up having the opposite impact on inflation to what the SARB intended.
While we’re not suggesting that you should try to predict interest rate movements, understanding the economic factors that drives these movements will help you in your investment decisions.