South Africa’s hike in its policy rate on Wednesday failed to impress traders who sold off the rand within 15 minutes of the hike announcement, driving it down by more than 3 per cent to 11.33 to the US dollar.
Speaking after the hike was announced, Ishitaa Sharma, a FX and rates strategist at Citibank said: “The markets are telling central banks they have to be a lot more consistent in their hawkishness.”
In advance of the South African rate hike, the rand had already weakened to 11.17 to the US dollar, a slide of 1.8 per cent. After the announcement, though, the rand fell further.
Economists had been expecting a rate increase later in the year. Instead, governor Gill Marcus pulled a surprise, announcing a 50 basis points increase to 5.5 per cent.
The market had been pricing in 100 basis points increase over the next six months, according to Barclays analysts, meaning rates should be up to 6 per cent by July at least. Several analysts were factoring in a 50bp increase by May. But not yet.
Up till now, the South African Reserve Bank has had something of a get-out-of-jail card with the lack of pass-through effect – in other words, the weakening rand has not pushed up inflation as much as you might expect. This lack of pass-through, which was recently described as “defying historical trends up to now” by Jeffrey Shultz of BNP Paribas, has meant that CPI has stayed under the Bank’s target rate of 6 per cent, with CPI coming in at 5.4 per cent in December.
As Marc Ostwald of Monument Securities put it: “the SARB has thus far been able to escape the ‘slings and arrows of outrageous fortune’ that have befallen the likes of Turkey, despite a protracted slide in the rand”.
However, the SARB isn’t taking this pass-through for granted, predicting higher inflation in the coming year. This from the statement:
The headline inflation forecast of the Bank has deteriorated since the previous meeting of the MPC, mainly as a result of revisions to the assumptions regarding the rand exchange rate. The forecast average inflation rate for 2014 is 0,6 percentage points higher at 6.3 per cent, and 0.6 percentage points higher at 6.0 per cent in 2015, with inflation expected to average 5,9 per cent in the final quarter of that year. Inflation is expected breach the upper end of the target range in the second quarter of 2014, and to reach a peak of 6,6 per cent in the final quarter of the year, before declining to 6.0 per cent in the second quarter of 2015.
The other pressure for South Africa’s MPC was that its decision came just before the US Federal Reserve announcement. The MPC may well, like the market, be expecting a further tapering of QE by the Fed, but it couldn’t be sure. And increases this week by India and Turkey have shown the way.
As Barclays noted before the decision:
Rate hikes by other EM against a backdrop of probable Fed moves tonight [Wednesday] to further reduce the size of the taper (by $10bn according to both our and consensus expectations) could further increase pressure on the rand if the SARB does not raise rates at the MPC this afternoon.
But with higher fuel prices due to weigh heavily on inflation later in the first quarter the corner, the SARB was forced to act at some point – as it has acknowledged. It was a question of when.
And for the SARB, the answer was: “now”.
S Africa: MPC faces tough choice as EM turbulence grows, beyondbrics
EM sell-off speaks to rate rise challenge, FT
Central bank fightback boosts currencies in emerging markets, FT