Thread: Time to really tighten your financial belts

Usually whenever the South African financial authorities sneeze, Namibia tends to catch a cold. Although BON governor Tom Alweendo has sprung a surprise or two by NOT increasing rates in sympathy with his SA counterpart, Tito Mboweni, the chances are more than anorexic that a hefty rate hike will not be followed by similar hikes locally:

Johannesburg - LOCAL markets are braced for a full percentage point hike in lending rates - the biggest in nearly five years - when the Reserve Bank's policy meeting ends this week.

Speculation is also rife that there will be a further 50-basis-point rise in interest rates at its next scheduled meeting, in August, to tame runaway inflation.

"Prolonged inflation risks create a stronger argument for decisive monetary tightening," Razia Khan, Standard Chartered's research head for Africa in London, said. "It's a tough call ... but a 100-basis-point hike now looks probable."

The decision of the Bank's seven-member monetary policy committee is due on Thursday, after two days of deliberations.

Bank Governor Tito Mboweni set the scene for a rate hike of that magnitude two weeks ago, with a warning that "drastic measures" were needed to tame soaring inflation.

The Bank's chief economist, Monde Mnyande, reinforced the speculation last week, saying SA's main inflation gauge would return to its 3%-6% target range only in 2010.

That is later than the Bank expected when it last raised interest rates in April. At that time, it said the annual rise in CPIX would be back in its range by the final quarter of next year.

The key inflation index has also surged more than the Bank predicted in April, when it said CPIX would peak at 9,3% in the first quarter of this year. The index, which measures consumer prices excluding home loans, rose by 10,4% in April and has breached its target range for 13 months in a row.

It is now expected to peak well above its previous record of 11,3% in the third quarter of this year, as double-digit wage raises and higher electricity tariffs add to price pressures sparked by the rising cost of food and fuel.

Weakness in the rand, which slipped to a near two-month low at R7,89 to the dollar last week, will also fan inflation as it makes imports more costly.

"We think that the Bank, by taking dramatic action now, will benefit in the long term from a fall in the inflation premium," Lehman Brothers economist Tolga Ediz said.

Eighteen of 22 economists polled by Reuters expect the Bank to raise its repo rate to 12,5% from 11,5% now -- taking the cumulative rise since June 2006 to 5,5 percentage points.

Fifteen predict another half-percentage-point increase in August, while two expect a second one-percentage-point hike.

Local money markets have "priced in" a full percentage point rate hike this week, but have scaled down expectations of another hike in August to a 40% probability.

Khan said Bank officials had had ample opportunity to offer "guidance" to local markets, if they were making the wrong assumptions. "They did not, and this is significant."

Instead, a stream of rhetoric, mainly from Mboweni, has highlighted the prospect of higher interest rates and further "pain" for consumers.

But the argument for a half-percentage-point rate hike this week is compelling, and two highly respected institutions, Standard Bank and the Bureau for Economic Research (BER), predict this will be the outcome.

"Near the end of the interest rate cycle the impact is always exponentially larger than at the start," Standard Bank's Danelee van Dyk said. "A 50-basis-point hike now would have the same impact as 100 basis points when rates started rising. That's why we are sticking to our view."

It takes interest rates up to two years to make themselves fully felt in an economy, and supporters of a smaller hike point out that SA's growth is already slowing sharply.

"It's a very close call -- our view was decided by the fact we think the evidence is on the table that the economy has reached a tipping point," said the BER's Pieter Laubscher.

"We think it will be clear that there is a danger a sharp tightening of interest rates may gain little in the way of improving the inflation outlook, while damaging the real economy," he said.

Economic growth slowed to an annualised pace of 2,1% in the first quarter of this year -- a six-year low -- from 5,4% in the previous quarter, hampered mainly by the effect of power outages on mining output.

Manufacturing production, which accounts for 16% of the economy, also fell, and official data due on Wednesday will show whether the trend is likely to be sustained.

In March, output fell by an annual rate of 1,1%, but a key survey suggests the sector may have rebounded in April, mainly due to the timing of Easter holidays in the previous month.

"Suffice to say, a recovery in April does not suggest the sector is out of the woods yet," Van Dyk said. Local supply constraints and rising interest rates would continue pushing up factory costs, which were also pressured by rising commodity prices, she said.

A business confidence survey from the BER, also due on Wednesday, is likely to highlight the dismal mood in the economy after slumping to a seven -year low in the first quarter.

Consumer spending, the main engine of growth, is slowing sharply as the rising cost of debt erodes disposable income.

"The economy is clearly experiencing stagflation -- growth is falling, inflation is rising and unemployment is high," Brait economist Colen Garrow said.

"Overtightening of interest rates will inevitably undermine growth, without dealing effectively with the factors which have pushed prices higher -- food and energy costs."

Business Day (Johannesburg)