Interest rates ahead?

There has been a long-held expectation that the current low interest rates will hold for the foreseeable future. There are certainly enough reasons for South Africa and Namibia's central banks to leave interest rates as is. Economic growth is under severe pressure, and inflation is low. In South Africa, who have an inflation target set between 3% and 6%, the current 3.2% inflation rate means that any fear of rate increases is unfounded. Furthermore, local credit growth is meagre, and one would expect the central banks to wait to see better and sustainable growth figures before looking at interest rate increases.

Interest rate adjustments are a mechanism used by central banks to achieve price stability as part of their monetary policy.  So, a central bank would only alter the interest rates to stop severe price fluctuations or keep inflation in check. However, in some cases, interest rate adjustments have little or no impact on price stability. 

For example, let's look at the recent fuel price increase. The price increase is predominantly because of higher international oil prices that necessitate fuel price increases domestically. Higher fuel prices will create inflationary pressure, which could create expectations of interest rate increases to help curb rising inflation.  However, higher interest rates, in this case, will have little impact on inflation.  It's the higher price of oil that pushes inflation upwards and simply raising local interest rates will not address the problem. On the contrary, an interest rate increase will place pressure on the economy, and could achieve little in lowering inflation.

The same logic applies to rising electricity prices in South Africa.  Higher interest rates won't push these prices down, so central banks need to determine whether inflation is fueled by administrative costs like electricity or by consumer demand.  An increased interest rate will suppress spending and can dampen demand from consumers, provided this is the problem. However the 2% credit growth in Namibia and 3% in South Africa shows this is clearly not the problem.

It is interesting to see that the South African futures contracts curve has recently indicated that the market expects an interest rate increase in 2021. Also, the long-term bond curve in South Africa has risen by around 0.5% on the short end of the curve, indicating there is a market expectation that interest rates will rise by year-end. I feel that this is very premature and that a few aspects need be addressed before we can talk about interest rate increases. First of all, there will need to be an increasing and sustained higher inflation rate trend here and in South Africa. 

With South Africa's inflation just above the lower band target, we are still waiting for signs of higher inflation. Also, one would have to see a drastic increase in credit growth figures at a sustainable level – at least double digits.  Before this happens, the best economic growth scenario would be to keep interest rates as-is for at least the next 12 months. Raising interest rates now just to lower them again at a later stage will put undue pressure on consumers and the economy and do little for price stability.