UPDATE 2-South Africa raises rates, rand still pummelled

Wed Jan 29, 2014 11:14am EST

* Central bank lifts repo rate by 50 bps to 5.5 pct

* Cites inflation risk; rand continues to plunge

* S. Africa follows tightening by Turkey, other EM

* Could undermine already slow growth

By Xola Potelwa

JOHANNESBURG, Jan 29 (Reuters) - South Africa raised interest rates for the first time in nearly six years on Wednesday, keeping in step with attempts by Turkey and other emerging markets to shore up their currencies, but markets viewed the move as inadequate.

The rand reeled more than 3 percent to a five-year low of 11.3800 against the dollar after the central bank announced it was raising its benchmark repo rate by 50 basis points to 5.50 percent. The currency was still down 2.2 percent by 1416 GMT.

South African Reserve Bank (SARB) governor Gill Marcus said the rate rise was aimed at containing inflation and had not been influenced by Turkey's huge surprise rate hike on Tuesday to support the lira. Nor was it meant to affect the rand's exchange rate, she said.

However, it came as South Africa's currency has become caught in an intensifying emerging market sell-off that has seen it lose 7 percent against the dollar so far this year.

The rand is one of the so-called Fragile Five most vulnerable emerging market currencies due to investor unease about South Africa's high current account deficit and the impact of a reduction in U.S. monetary stimulus.

Marcus predicted more currency turbulence as the U.S. Federal Reserve continues to wind up its bond-buying programme.

On the day, the rand swung within a 4.3 percent range, its most volatile trading session in more than three years.

"Exchange rate pressures are expected to intensify as markets adjust to the new pattern of global capital flows," Marcus told a news conference, adding the primary responsibility of the bank was to keep inflation under control.

The bank targets headline inflation of between 3-6 percent, but sharply raised its forecast for average inflation this year to 6.3 percent, from 5.7 percent forecast previously.

At the same time it cut its growth forecast for Africa's biggest economy. It now expects GDP growth of 2.8 percent this year, down from 3 percent seen at its previous meeting in November.

The interest rate rise risks further denting growth and could cause tensions with the ruling African National Congress (ANC), which faces a tough election in around three months.

MORE RATE RISES SEEN

South African Forward Rate Agreements (FRAs) due in 12 months jumped to more than 7 percent, suggesting rates could go up by another 150 basis points before the end of this year.

"The decision to hike rates has no doubt been a begrudging response to global factors beyond the control of the SARB as monetary authorities would have been under political pressure to keep policy accommodative," Tradition Analytics said.

While the ANC is expected to win the election comfortably, its standing has been damaged by the struggling economy, typified by chronic unemployment and widespread social and labour unrest.

In the last two weeks, at least seven people have been killed by police trying to control riots over poor public services in black townships that have seen little improvement in the quality of life since the end of apartheid in 1994.

Trade union federation Cosatu, a formal member of a governing alliance with the ANC, condemned the interest rate hike, saying it would hit growth and jobs.

"While inflation is always a potential danger, it is far less of a problem than South Africa's appalling levels of unemployment and poverty, the ticking time-bombs which are already starting to explode in community protests," it said.

The mining sector, a major source of foreign exchange, continues to be plagued by strikes, with many platinum mines at a standstill due to a week of industrial action.

Unions and management met for a fourth day of talks on Wednesday, but an offer from platinum producers was well below the union demands.

Disputes are harming economic growth, which eased to 0.7 percent quarter-on-quarter in Q3, its slowest pace since a 2009 recession.

Interest rates had been on hold since a cut in July 2012 and two people on the bank's seven-member policy committee wanted to keep the repo rate at 5.0 percent on Wednesday, reflecting concerns about the impact of higher borrowing costs on the economy.

South African bonds fell heavily on the central bank's deteriorating inflation outlook with yields on the short-dated 2015 bond rising 30.5 basis points to 7.0 percent.

All 34 economists surveyed by Reuters last week - before Turkey's rate hike - said the bank would keep the repo rate on hold.

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