Are we in for Some Interest Rates Positivity?
21 July 2016
You can also listen to these podcasts directly from the Old Mutual app, which is available here.
On mobile, on digital, on demand, this is Old Mutual Live, the Money Coach edition. Hello and welcome, my name is Chris Gibbons. Later this week the South African Reserve Bank will announce its latest decision on interest rates. Something that will affect all of us one way or the other.
Which way is it likely to go and what are the implications? Joining me now from Cape Town is Old Mutual strategist, Izak Odendaal. Izak, welcome, good to have you with us. First off, in basic terms, what are the factors that go into the Reserve Bank’s decision?
What impacts the decision
Izak Odendaal: The Reserve Bank is primarily concerned with inflation and therefore it will look at the factors that drive inflation over the next year to two years because it is forward looking. Important things would be the exchange rate, the food prices, oil price, electricity tariff increases, all kinds of factors that ultimately determine the inflation rate.
But they will also take a view on economic growth. So we’ll look at global growth and also local growth. Although inflation is their primary target, they do also keep growth in mind. Because if you increase interest rates, you do tend to harm growth. They will want to achieve some sort of balance between achieving an inflation target, but not growing too much.
CG: A lot of people say it’s unfair that if inflation is caused by something beyond their control, like the price of fuel or the rand/dollar exchange rate. That they should be punished by higher interest rates, do they have a point?
IO: Well, the way the thinking goes at the Reserve Bank and at most central banks globally is that you don’t respond to, what they call ‘the first round impact of a price change. For instance, if the petrol price goes up, like we saw earlier this month, that’s not something the Reserve Bank is going to be concerned about. Because it’s a once-off move.
What they’ll be concerned about is whether the higher petrol price causes retailers to push up, for instance, their prices. Which in turn causes unions to push up their wage demands. That is what they call the ‘second round impact’ of a price increase.
So that’s really what they’re trying to address is; if there are changes in things like the exchange rate or the oil price, which you’re quite right, are not under the control of the Reserve Bank, could those changes still over time cause inflation to increase.
CG: Where then does the additional money raised by the higher interest rates go? Who scores?
IO: Well, very simply the Reserve Bank pushes up the cost that banks have to borrow from it. Therefore the banks push up the cost that consumers borrow from them. In that sense the extra money doesn’t go anywhere. But some people do benefit from higher interest rates. Mainly if you have money in an interest bearing account at a bank or a bank deposit, it obviously gets a benefit there of higher interest rates.
What we can expect this time
CG: All right, so there’s the background Izak, what is likely to happen this time around and why?
IO: Well, I think the Reserve Bank is unlikely to increase interest rates this week. They have already increased interest rates by 200 basis points over the last two years. So they’ve already done quite a bit and I think they’ve done enough.
If you look more closely at some of the factors that I mentioned upfront, a lot of those have actually moved in our favour. The exchange rate was above R15 to the dollar at the time of the previous monetary policy committee meeting. That’s now sitting closer to R14, just above R14.
The global oil price has softened a bit, global food prices have come down. So a lot of the factors that were causing anxiety about rising inflation a couple of months ago have now eased. I think that combined with the fact that the economy is still under-performing, growth is still weak, households are under pressure, consumer spending is sluggish; if you combine those factors, I don’t think there’s any further room for them or any further need for them to increase interest rates at the moment.
I think a big thing that they’ve been worried about over the last, actually year or two, is the Rand. How does the Rand respond to when the American Central Bank Federal Reserve starts increasing their interest rates. I think what we’ve seen from the rand the last couple of weeks, especially after the Brexit vote on all the global volatility is that the Rand’s actually been quite resilient. I think that’ll give them a measure of comfort in their decision making.
CG: You’re listening to Old Mutual Live, the Money Coach edition, on demand, visit dogreatthings.co.za. Now, if rates are kept the same, could we see, do you think, another hike later in the year?
IO: It’s not impossible. Again, if some of these factors change and their forecast for inflation over the next two years’ changes; cause again, remember, an interest rate move doesn’t impact the economy or inflation. The short term, it takes time to have an impact. So they need to, whatever they do, they need to be sure that it’s going to be the right thing a year, 18 months, two years from now.
If the inflation outlook worsens again, then yes, they could hike interest rates. But I think there’s a fair chance that we are at or very close to the peak of this interest rate cycle, which means that in a couple of months’ time we will probably start thinking about when the first interest rate cuts could take place. Maybe sometime next year.
How under pressure is our economy?
CG: There’s certainly been a number of economists critical of the Reserve Bank in general at the moment, saying we are the only country in the world whose economy is so close to recession. Yet we have been raising interest rates, what’s your view?
IO: It really depends. We are not the only economy, if you think of the Brazilians hiked interest rates despite being in a very deep recession. The crucial thing here is the credibility of the Central Bank. If people believe that Central Bank is serious about inflation. Then people will generally change their behaviour, their price setting behaviour in accordance with that.
If people believe that the Reserve Bank is serious about 3-6%, then they will change the way they negotiate contracts. They will change the way they negotiate wages. They will change the way they negotiate prices. As a result, inflation will be between 3-6% over time. But that’s if the Reserve Bank is believable, if it is credible, if people have faith in that institution.
If you don’t have faith in the institution, then the Reserve Bank, the Central Bank has to demonstrate that it is serious. That’s exactly what happened if Brazil. It’s a country with a history of hyperinflation and the Central Bank really has to take quite extreme measures to get people to believe that it has inflation under control and it will get inflation under control.
Our Reserve Bank is not quite in that extreme position, it has a great degree of credibility. But we are an emerging market and therefore I think we do need to spend a little bit more to gain that credibility. Having said that, you can always argue whether there have been one or two interest rates too many. But the general direction of interest rates over the last two years, you can’t really fault them for that.
CG: This has been another edition of Old Mutual Live, Money Coach, my name is Chris Gibbons. With me on the line from Johannesburg has been Izak Odendaal, Strategist at Old Mutual. Izak, thanks for having been with us.
Remember, please feel free to get in touch any time. If you have any questions for me or topics you’d like covered on Old Mutual Live Money Coach, please feel free to send them direct to me at firstname.lastname@example.org. I’d be delighted to hear from you. Until the next time, thank you for listening, Old Mutual Live, on mobile, on digital, on demand.