The South African Reserve Bank’s monetary policy committee (MPC) decided to hike the key interest rate by 50bp to 7.50% at today’s monetary committee meeting - the decision was a bolt from the blue.

The decision likely came as a reaction to increasing inflationary pressures in the economy as a result of strong domestic demand and high oil prices. Adding to South Africa’s woes of late have been the recent slide in the rand, which has been following commodity prices south, increased global aversion to risky emerging markets and last but not least the worsening current account deficit.

While we did not expect a hike at today’s meeting, we had stressed that the bias was on the upside, as the SARB governor, Tito Mboweni, had reiterated several times that the monetary bias was towards tightening. The SARB governor spoke about the situation in the South African economy before the announcement, saying that inflation risks had increased over the past few weeks and that the outlook had deteriorated significantly. Mboweni said that CPIX inflation is expected to peak at 6.2% - above the inflation target of 3% - 6% in the first quarter of 2007. High oil prices were the main culprit behind the deterioration in the outlook.

While high oil prices were the main risk to inflation and therefore a major reason for the rate hike, we believe that the recently sliding rand - which will likely come under further pressure on the back of the ECB rate hike and the expected rise in US interest rates - lent support to the decision.

SOURCE: Danske Bank