SA’s current aggressive interest rate cycle

The current interest rate cycle has been more aggressive than predicted, with interest rates rising 425 basis points since November 2021. Despite the prime lending rate increasing from 7% to 11.25%, it appears to have had little impact on inflation, which remains well above the target of 4.5%. At the same time, higher rates are placing households and small businesses under significant financial pressure.Has the interest rate cycle reached a point where higher rates will do more harm than good?In a traditional economic framework, inflation is a result of high demand – too much money chasing too few goods. This is a good description of inflation in many developed economies, which experienced years of exceedingly low interest rates. But that is not what is driving inflation in South Africa. There is virtually no demand here, as our economy faces recession.As Stanlib economist Kevin Lings explains, the start of the inflation cycle was driven by external factors, including global inflation, higher oil prices and Russia’s invasion of Ukraine. The South African Reserve Bank’s quick reaction to hike interest rates was to curb “second-round inflation”. This is where price and wage increases are based on expectations of higher prices. This expectation becomes an internal driver of inflation and, suddenly, you have rampant inflation rates that become hard to contain.As political analyst Johannes Landman points out, inflation hurts the poor the most. While home owners with bonds and consumers with car finance will struggle with higher interest rates, rapidly rising food and transport costs have a far greater impact on the poor.The problem with rising prices, unlike interest rates, is that they never come down again. While interest rates can be cut, and will be, the price of bread never reduces.LoadsheddingLoad shedding is driving food prices ever higher, and the amount of money food producers and retailers are having to spend on alternative power is being passed on to consumers.Then there is imported inflation.“If you look at something such as stationery, the prices have increased by 10%. This is not being driven by demand, but by global inflation and a weaker currency,” explains Lings.As the rand weakened and global prices rose, so too did the cost of stationery.“A store owner has a choice – either increase the price by 10% or stop selling [the item],” says Lings.He says there is also opportunistic pricing of goods.“Inflation on school education is now over 6%, and we are seeing double-digit figures at private schools because they can pass on the price increases as parents are prepared to pay to educate their children.”So, if all of these price increases have nothing to do with demand, why then are we continuing to use the destructive instrument of higher interest rates?What would the inflation rate be if we did not have interest rate increases? Possibly a lot worse. If demand-driven inflation was added to cost-push inflation, Lings says we could experience double the rate of inflation.Geoff Blount, the chief investment officer at private equity firm Invequity, says that, when inflation is cost-push driven, you could take interest rates up to 30%, but it would not pull inflation down.One of the things interest rates do in South Africa is attract investments. Foreign investors looking for higher returns will watch the interest differential between countries. “If we lag behind our trading partners and other emerging economies when they are increasing interest rates, the rand weakens and we have imported inflation. So, interest rate hikes work, but for different reasons,” says Blount.ExpectationsLings points out that, in March, when the Reserve Bank increased interest rates by 50 basis points, which was higher than expected, the rand strengthened.“The Reserve Bank would not want to be out of step with the rest of the world when it comes to interest rates,” he says.Higher interest rates also signal that the Reserve Bank is serious about containing inflation, and it keeps wage increase expectations under control.While everyone would love a large salary increase, higher salaries become a higher input cost for a company, which in turn drives up the cost of production – and therefore raises overall inflation levels.As we enter a period when it appears as though central banks around the world are pulling the foot off the interest rate pedal, is this an opportunity for the Reserve Bank to pause and let the current interest rates hikes take effect? In this environment, would higher interest rates cause more harm than good?Lings says that, with the current interest rate being the highest in 14 years, there is a real risk that further rate hikes could make matters worse.“If you push rates up further, you do more damage to households and business. If businesses close and there are further job losses, that results in less economic activity and less tax revenue. Now you have a weakening economy, resulting in lower tax collection.”That then becomes a problem about fiscal stability, with worsening sovereign credit ratings and foreign investors becoming wary.“If consumers start defaulting on debt, then there is a concern about the stability of the banking system. At that point, interest rates are doing more harm than good.“One is inflicting so much damage that you make the government’s fiscal situation unattractive for investment,” Lings says.-Fin24

SA’s current aggressive interest rate cycle

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Namibian Sun 2025-02-25

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SA’s current aggressive interest rate cycle

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Namibian Sun 2025-02-25

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