allAfrica.com: South Africa: Rates Outlook (Page 1 of 1)

RIGHTLY or wrongly, further increases in interest rates appear inevitable.

Local money markets have fully priced in expectations the Reserve Bank will raise its key repo rate by half a percentage point to 12% at its next policy meeting in mid-June, taking prime lending rates up to 15,5%. They also predict interest rates will rise at least once more before the end of this year, taking lending rates to levels last seen in 2003, after a dramatic plunge in the value of the rand also ignited double-digit inflation.

Markets are not always correct, but governor Tito Mboweni has done his bit to prepare us for the worst after news that SA's main inflation gauge rose by 10,1% in March -- its fastest in more than five years. Factory inflation for the same month dealt a similar blow, rocketing 11,8% in a trend which suggests upward pressure on consumer inflation in the next few months. Mboweni warned that the inflation situation was "deteriorating" and there could be an emergency meeting of the Bank's monetary policy committee (MPC) before its scheduled June 11-12 date. Bank officials quickly moved to dispel rumours that a meeting had already begun, and most analysts believe an early policy decision is unlikely, as it would smack of panic. But Mboweni's comments prompted serious soul-searching, with most analysts rushing to update their forecasts for inflation, which has now breached its 3%-to-6% official target range for a full year. As a result, many abandoned the view that interest rates will stay on hold after a cumulative 4,5-percentage- point increase since June 2006.

Changes in interest rates take up to 18 months to make themselves fully felt, and there is plenty of evidence that policy tightening is eroding consumer spending, the economy's main growth engine.

It can also be argued that since inflation is being driven mainly by the relentless rise in global food and oil prices, raising interest rates is a futile exercise. Sadly, the "second-round" impact of inflation is spreading and feeding into inflation expectations, which become a self-fulfilling prophecy. Labour federation Cosatu has already warned it will not settle for single-digit pay increases this year. Even if double-digit wage hikes do not materialise, increases will probably amount to at least 8%, up from 7% last year. That will help compensate for the rising cost of living, but may also make it become more entrenched -- a situation the Bank wants to avoid.

A few weeks ago the outlook for interest rates appeared to hinge on whether power utility Eskom got the go-ahead to raise its tariffs by 53% this year -- a development that could add up to two percentage points to annual inflation. Now, the decision from the National Energy Regulator of SA -- due a week ahead of the Bank's next meeting -- is likely to determine not whether, but how much further, interest rates will rise. Everything points one way. Local petrol prices climbed 8% last month and 6,2% this month -- months for which the inflation increase is unknown. SA is one of the world's top importers of rice, and its price will rise 30% this month. It seems clear that inflation measured by CPIX will breach its previous record of 11,3% in the next few months, and one top analyst predicts it will reach a whopping 15% later this year. All in all, the Bank will have little choice but to raise interest rates to maintain its credibility as an inflation fighter.

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