THE Reserve Bank signalled on Thursday that more hikes were to come as it raised interest rates by a hefty 50 basis points.
Worries about rapidly rising inflation outweighed concerns about economic growth that is anaemic.
The rand rallied the most in six weeks on the news to about R16.15/$, but it remained to be seen how long this would last.
Last year, the Bank raised rates only twice — each time by 25 basis points.
A sharply depreciating rand and much higher food prices would in the main fuel higher inflation, the Reserve Bank’s monetary policy committee (MPC) warned.
"The committee faced the continuing dilemma of a deteriorating inflation environment and a worsening growth outlook," said the Bank’s governor, Lesetja Kganyago.
The Bank once more emphasised that constraints to SA’s growth were structural and could not be solved solely by monetary policy.
It revised economic growth forecasts sharply down to 0.9% this year from 1.5% in November. Growth for next year was changed to 1.6% from 2.1%. The effect of the weak rand will be worse than has been anticipated.
The Bank reviewed its inflation forecast for this year to 6.8% from 6% and that for next year to 7% from 5.8%.
These are way outside of the 3% to 6% target band it aims for.
Inflation is also seen remaining outside the top of the band from now until the end of next year.
It is now expected to peak at 7.8% in the fourth quarter of this year as opposed to an earlier estimate of 6.1%. The softer rand also means SA will miss out on the benefits of lower oil prices.
The persistent drought and need to import some staples such as maize with a weaker rand are expected to push up food prices to much higher levels.
Food inflation is projected to peak at about 11% in the fourth quarter of this year. It is currently sitting at 5.8%.
The rates decision on Thursday was more about reversing capital flight, Lefika Securities economist Colen Garrow said. But Mr Kganyago said: "It would not be an easy proposition for SA to say that we are hiking rates in order to stem the outflow of capital."
The Bank did flag as a matter of concern the rate at which a depreciating rand was filtering through to domestic prices.
Higher inflation would necessitate more rate increases.
The MPC was split on the rates decision, which hints that it would not have been an easy meeting.
Three members voted for rates to rise 50 basis points, two wanted a 25 basis-points increase, while one felt that unchanged rates were suitable.
The perception that recent rand weakness was mainly due to domestic issues could have put the Bank under more pressure to raise rates aggressively, Standard Chartered Bank’s Africa chief economist Razia Khan said."With SA facing the risk of further rating downgrades, given disappointment over institutional strength and a perceived deterioration in the political backdrop, there may have been more pressure than usual on the Bank to act," she said.
SA needed higher interest rates to entice foreign investors and compensate them for the additional risks they faced given a deterioration in the country’s sovereign credibility, FNB chief economist Sizwe Nxedlana said.
"That we are now perceived as a riskier investment destination is reflected in the sharp increase in government borrowing costs since early December.
"Failure by the Bank to react to this with higher interest rates could threaten even more rand weakness and higher inflation," Mr Nxedlana said.
With rates having been raised 50 basis points on Thursday, Ms Khan expected "an extended" pause before rates are hiked again.
The weak rand and higher food prices are not only negatively affecting consumer, but producer inflation as well. Producer inflation accelerated to 4.8% year-on-year last month, from 4.3% in November, amid rising food and machinery prices, Statistics SA data showed on Thursday. Food prices are rising, as drought has caused production shortages and necessitated imports, which are more expensive because of the weak rand.
The consensus was for rates to rise by 25 basis points, although some economists surveyed had predicted the 50 basis points increase. The latest increase takes the repo rate to 6.75% and the prime rate — the rate at which banks lend to consumers — to 10.25%.
Property groups and trade unions are among those opposing the rate hike, saying it will put more financial strain on over-indebted consumers and slow down growth in household spending.