Could interest rates be raised for the first time in 14 years?
Mbongeni Mguni | Monday February 7, 2022 06:00
Local asset management firm, African Alliance, believes interest rates could rise by as much as 100 basis points this year, the equivalent of one percentage point, a major jump particularly given that the central bank has been lowering interest rates gradually since as far back as 2008.
“Our house view is for 50bps to 100bps in rate increases this year and this is informed by the BoB’s December Monetary Policy Report where the bank indicated that it expects inflation to average 10.4% in the first quarter of 2022, which will likely force the bank’s hand,” says Nlume Modise, chief investment officer at African Alliance Asset Management.
Essentially, borrowers can expect their loans to become more expensive this year. Should a 100 basis points increase be made, the bank rate would rise to 4.75 percent while the prime lending rate would shift to 6.25 percent. The rates for other credit products would similarly rise.
The challenge technocrats at the central bank have is that while inflation is hovering at nine-year highs, with the expectation of shooting beyond 10% in the short term, economic growth is still unsteady and requires support from monetary policy.
The central bank had initially expected to forecast that inflation would return to the official three to six percent target range by the second quarter of 2022. In December, the BoB revised the return to the third quarter of 2022, saying this would be caused by the private school fee increases in the first term and rising international oil prices.
However, between now and the third quarter lie other potential increases in electricity tariffs, Botswana Housing Corporation rentals, the expected introduction of a digital tax and other increases.
“Inflation is itself inflationary, meaning that when the rate rises, the market begins to have high expectations that inflation will continue rising, which may lead to more increases being made to the prices of certain goods and services,” an analyst at a local bank explains.
“The BoB attempts to manage inflation expectations through forecasts such as saying it will return to the target range by the third quarter, but when the rate jumps beyond 10%, it may be forced to implement a bank rate increase in order to more forcefully set inflation expectations.”
The analyst adds that another incentive to hike interest rates would be to attract greater capital inflows into the country. The country has been experiencing capital flight where local investors have preferred to invest in regional and international assets, which offer higher yields than available locally. The challenge is most visible in the tepid uptake of government bonds throughout 2021.
For Modise, in terms of adjusting interest rates, a gradual balancing act is required between inflation and economic growth.
“The balancing act is to be gradual with increases so as to not choke off a still nascent economic recovery from 2020’s lows,” he says.
“This is important as the economy is expected to grow at below long-term trend levels in 2022 and remains some way off growth rates expected of economies at this stage of their economic development cycle.”
Since October 2020, interest rates have been at their lowest in history, with the bank rate, which anchors most other rates in the market, sitting at 3.75 percent. The prime lending rate, or the rate which banks give to their best customers, has also been at 5.25 percent, another record low, since October 2020.
Bank rate adjustments are the BoB’s key tools for managing inflation as they increase or decrease the ‘price’ of money and thereby, influence the demand for credit and with it the amount of spending going on in the economy.
In periods when inflation, which is the rate of increase of the prices of goods and services, rises beyond certain parameters, the BoB has stepped in to increase interest rates, which encourages saving and reduces non-productive spending.
When inflation spiralled in the country in 2008, reaching nearly 13%, the BoB responded by hiking the bank rate to 15% in May of that year, and then further increased it to 15.5% just over a month later.
Since then, however, inflation has eased from those highs, allowing the BoB to adopt an “accommodative monetary stance”. The shift in the winds was timely, as the central bank was being bitterly criticised for its austere monetary policy, with commentators saying monetary policy should rather focus on supporting economic development than being solely focussed on managing inflation.
The “accommodative monetary policy stance” leverages on benign inflation to lower interest rates and in turn assist economic growth through more affordable money in the market.
The accommodative stance is one of three positions the BoB can take, the other being neutral or austere, where interest rates are rising. Each of these positions, which is largely informed by current and projected inflation, influences the direction interest rates in the market take each year.
The Monetary Policy Statement presented by the BoB governor after the budget speech each year, sets the tone for the monetary policy stance the bank will adopt for that year, while Monetary Policy Committee (MPC) meetings are held to update on the position looking at any developments in the domestic and external environment.
For the ordinary consumer, each of the six MPC meetings held by the central bank each year, bring with them the chance of having to pay more or less for a new or existing loan. Each MPC meeting discusses developments around economic growth and inflation at the global, regional and domestic levels before a decision is taken on the bank rate, which is the benchmark rate against which nearly all other interest rates in the market are based.
Inflation has fallen from those highs in 2008 to a record low of 0.9 percent in June 2020, supporting the accommodative stance and contributing to the greater movement of credit and money amongst different economic actors.
However, the wave of tax, levy and administered price increases that occurred from last April, saw inflation spiralling to a nine-year high in July at 8.9 percent and remaining around that level since then. With five fuel price increases during the year, inflation ended 2021 at 8.7 percent.
“It’s worth noting that the forecast (of 10.4% inflation) predated the December increase to public transport fares and petrol and diesel prices and may be compounded by tariff increases that may be announced at next week’s budget speech,” Modise says.
“We expect inflation to moderate in the second half of the year, which, coupled with below-trend growth expectations, does give the Bank room to be more gradual in its rate increasing cycle.”
At Stockbrokers Botswana, research analyst, Malebogo Keleapere says while the bank rate is expected to remain flat for most of this year, there is a possibility of an upward revision in the third quarter of the year. Should such a revision be made, Stockbrokers Botswana expects it could be by as much as 50 basis points, which is half a percentage point.
“We anticipate the bank rate to remain at 3.75 percent for the most part of 2022, with a possibility of revision during the third quarter of 2022,” she says.
“This will be on the backdrop of hiking inflation.”
She adds: “Should the revision take place, we anticipate that 50 basis points may be added on the existing 3.75 percent, which would shift people’s appetite towards saving than borrowing as borrowing will be expensive for them.
“Consequently, economic growth will be halted due to lower availability of credit and the rate of inflation will ultimately decline to within the bank’s objective range of three to six percent.”
Keleapere says alternatively, the BoB could ‘tighten monetary policy’ without necessarily raising the bank rate.
“This may be achieved through decreased bond prices and increased capital reserve requirement for banks,” she explains.
Kgori Capital analysts expect that a 25 basis point increase to the bank rate will take place sometime this year as the BoB “walks the tightrope between rising inflation and supporting economic growth”.
“We expect inflation to accelerate further in January 2022 due to the December 2021 increase of about 15% increase in pump prices.
“From there we expect inflation to decelerate but continue to trend above the BoB’s three to six percent objective range until the third quarter of 2022.”
The first indication of which way the BoB will move this year in walking ‘the tightrope’ in its balancing act, will come in a few weeks when central bank governor, Moses Pelaelo unveils the annual Monetary Policy Statement (MPC), outlining the monetary policy stance for 2022. Shortly after, the MPC is due to meet on the bank rate for the first time.