Recession risk mounting. SARB to raise rates – ‘Will kill more growth’

It’s a classic battle between textbook learning and what’s happening on the ground. But make no mistake it’s not an easy situation the South African Reserve Bank finds itself in. The mandate is keeping inflation within the defined target of 3-6 percent but unemployment sits at 25 percent and the latest 2016 IMF growth forecast is 0.7 percent. The key driver of inflation is imported, which automatically points to increased interest rates but the reality on the ground is the country is staring a recession in the face. A Bloomberg estimate of nine economists points to a 45 percent chance that Africa’s most industrialised economy will contract for two successive quarters this year. The Monetary Policy decision is expected this afternoon, and while the consensus view is a 50 basis point hike, one wonders if the South African economy can handle that. Some out of the box thinking is needed from all parties involved, not just the Reserve Bank. – Stuart Lowman

By Mike Cohen and Sarina Yoo

(Bloomberg) — The risk of a recession in South Africa this year is mounting, making policy decisions more difficult for a central bank battling to balance the need to contain inflation and support a stuttering economy.

The likelihood of Africa’s most-industrialized economy contracting for two successive quarters in 2016 is 45 percent, according to the median estimate of nine economists surveyed by Bloomberg this month. That’s up from a 25 percent probability in December. Four of the analysts predict a recession this year. The International Monetary Fund has slashed its forecast for South African expansion by almost half to 0.7 percent.

Lesetja Kganyago, governor of South Africa's reserve bank, poses for a photograph wearing a South African coloured matching woollen hat and scarf in Davos, Switzerland. Photographer: Simon Dawson/Bloomberg
Lesetja Kganyago, governor of South Africa’s reserve bank, poses for a photograph wearing a South African coloured matching woollen hat and scarf in Davos, Switzerland. Photographer: Simon Dawson/Bloomberg

“The environment has just deteriorated,” Isaac Matshego, an economist at Nedbank Ltd., South Africa’s fourth-largest bank which puts the odds of a recession at 70 percent, said by phone from Johannesburg. “Commodity prices have dropped further, the rand has come under significant downward pressure. That will definitely have a negative impact on economic growth. We are looking for a number around 0.2 percent for this year.”

The rand has slumped 30 percent against the dollar since the start of last year, buffeted by the commodities rout, power shortages and a decision by President Jacob Zuma in December to fire the widely respected Nhlanhla Nene as finance minister that also sent bond yields soaring. Policy makers must weigh up how best to contain the resultant price pressures and keep inflation close to its 3 percent to 6 percent target band, without choking growth.

The bank will “act with resolve” if inflationary pressures from the weaker rand spread more broadly in the economy, Governor Lesetja Kganyago said in an interview with Bloomberg TV in Davos last week. He also said 25 basis points isn’t a “small” adjustment. Inflation climbed to a one-year high of 5.2 percent in December.

Forward-rate agreements, used to speculate on interest-rate moves, are pricing in 32 basis points of rate increases on Thursday, while contracts starting in 12 months predict the benchmark rate will be 1.6 percentage points higher in that period. The rand gained 0.1 percent to 16.3692 per dollar by 4 p.m. on Wednesday in Johannesburg, while the yield on the 2026 bond fell four basis points to 9.61 percent. Kganyago is due to announce the Monetary Policy Committee’s latest decision from 3 p.m. in Pretoria.

Read also: Gordhan promises: We’ll use Rand Crisis to reform SA, take tough decisions

All but two of the 26 economists surveyed by Bloomberg predict the central bank will raise the benchmark rate from 6.25 percent, with the majority anticipating more than the 25 basis-point adjustments made twice of 2015, even as economic growth prospects dim.

While the central bank’s mandate requires it to target inflation, it must also consider the impact monetary policy has on growth and unemployment, which stands at more than 25 percent. The extent of the rand’s decline may force Kganyago’s hand, at the expense of growth, according to Elize Kruger, an economist at KADD Capital that sees a 45 percent probability of recession.

“I now expect the Reserve Bank to hike rates quite aggressively,” she said by phone from Johannesburg. “That will kill more growth. The chances of a recession are now bigger than they were at the end of last year.”