Interest Rates hike puts more pressure on the economy

 By: Dawie Klopper – PSG Investment Economist

 Now that we have had the first interest rate hike in years, the upward cycle will not easily be stopped. It is expected that interest rates will rise with between 200 and 300 basis points in the next year or two.

I would have liked to see the Reserve Bank waiting with an increase until the US started to increase their interest rates. World economic growth, as well as our local growth rate is simply too fragile to justify such a move.

The South African Reserve Bank’s announcement of a 50 basis point increase in interest rates came as a big surprise and on which the rand reacted negatively. The increase follows recent interest rates increases in other emerging markets with an overnight increase of 6.25% in the lending rate of Turkey at the forefront. India also increased their interest rates.

Emerging markets have recently come under pressure, especially the so-called “fragile five”, referring to South Africa, Turkey, Indonesia, India and Brazil. This group of countries all have huge balance of payment deficits, as well as budget deficits which requires foreign investors to finance these shortages.

The American quantitative easing program made it, up until recently, fairly easy for these countries to finance their deficits due to the high levels of liquidity. It became apparent that the American economy was recovering and that quantitive easing was slowly being phased out.

Economists predicted that the five mentioned countries will struggle with investments and in particular emerging markets and as a whole, which in turn will lead to increased pressure on the interest rates. Speculators thrived.

The improved outlook for the American economy did bring growing uncertainty about the emerging world, with China and Brazil being at the forefront in particular.

Consumers in South Africa are under severe pressure. This follows years of salary increases for government officials and the left and right handing out of unsecured loans, proving now to be unsustainable. In addition, sharp increases in electricity tariffs and petrol prices, as well as e-tolling in Gauteng contributed to the mounting pressure.

The result of this weakening prospect for growth, is foreign investors moving their high risk investment funds to the developed world in search of better growth. This is putting these countries under severe pressure.

In my opinion, the main factor currently driving world markets (whether up or down), is growth. The Reserve Bank’s decision to increase interest rates must be seen as negative for growth.

Investors will then simply decide to withdraw investments, resulting in a weakening rand and more inflationary pressure, which is then argued as the reason why the Reserve Bank is increasing interest rates. They wanted to avoid a second round of inflationary pressure in the economy, but now the exact opposite is achieved.

I feel that the Reserve Bank should have warned of increasing inflationary pressure and in case of more pressure that they have had no other choice but to increase interest rates. Nothing more should have been done.

This would have showed the investment world that we understand how important growth is, but that the Reserve Bank will also not allow inflation to run ahead of us. We could have increased interest rates over two months, if it deemed necessary.

To argue now that the Reserve Bank should be ahead of the curve in order to avoid future pain, resulted in the pain hitting us sooner.


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