The South African Reserve Bank has fired the starting gun on monetary policy normalization, but economists do not expect the hiking cycle to be plain sailing.

The SARB on Thursday hiked its main repo rate by 25 basis points to 3.75% from its record low amid growing concerns about upside inflation risks. The central bank raised its consumer price index forecast from 4.4% to 4.5% in 2021, and from 4.2% to 4.3% in 2022.

The hike marks the first step to unwinding 275 basis points of cuts implemented since the start of the Covid-19 pandemic, but the Monetary Policy Committee split its vote 3-2, indicating conflicting sentiments within the SARB as it looks to support the recovery while addressing inflation fears.

Headline consumer price index inflation was a modest 0.2% month-on-month in October, an annual climb of 5%.

In his statement, SARB Governor Lesetja Kganyago noted that elevated oil and energy prices pose upside risks to the short-term inflation outlook.

Jeff Gable, head of macro and fixed income research at South African bank Absa, told CNBC Friday that the repo rate rise had come a little earlier than many economists had expected, and showed the bank’s concern about upside risks to inflation. However, projections remain around the center point of the SARB’s target for now.

“We know that in South Africa we have tens of millions of vulnerable South Africans not really in a position to be able to protect themselves from inflation, and so [we have] a Reserve Bank here that has needed to be talking tough about inflation throughout the cycle,” Gable said.

“So this signal, this first rate rise a little earlier than we expected, is certainly an indication, I think, that they want to stay on top of it.”

A gradual hiking cycle

Gable said it remains to be seen whether the unwinding of the SARB’s accommodative position comes in successive policy meetings, or whether the market will be on tenterhooks each time the MPC gets together over the next couple of years.

Virag Forizs, emerging markets economist at Capital Economics, said in a note Thursday that the decision indicates a slower tightening cycle than markets had anticipated.

Kganyago said the MPC believes a “gradual rise in the repo rate will be sufficient to keep inflation expectations well anchored and moderate the future path of interest rates.”

“This dovish bias probably helps to explain why the rand initially weakened against the dollar following the decision,” Forizs said.

“In addition, MPC members will probably want to keep monetary policy as accommodative as possible to continue supporting the economy.”

Capital Economics has penciled in 150 basis points of hikes over the next two years, with the repo rate rising to 4.5% by the end of 2022, and to 5.25% by the end of 2023.

By contrast, Forizs highlighted, the market is pricing in around 250 basis points of hikes within the next 18 months.

Growth outlook clouded

The economic recovery has been rocky thus far. Covid lockdown measures and pockets of civil unrest have weighed on activity at various points throughout the past two years.

While the SARB expects annual GDP growth of 5.3% in 2021, it has sharply lowered its 2022 projection from 2.3% to 1.7%, and 2023 from 2.4% to 1.8%.

What’s more, the country is battling to implement fundamental economic reforms after years of sluggish growth. Education, infrastructure, labor, public sector wages and the privatization of state-owned enterprises are all on the table in discussions.

However, Gable noted that divisions within the ruling ANC party have caused a “logjam” that has rendered progress difficult.

“A South Africa that grows 1.75 to 2% over the medium term is not a South Africa that is growing fast enough to bring about meaningful change to the social challenges in the country, the inequality in the country,” he said.

“So we would expect, I suppose, a ratcheting of tensions, a ratcheting of pressure for change, but still this concern about just where the agreement is as to what direction that broader change needs to take.”

Conflicting views on the rand

JPMorgan on Friday cut its position on the South African rand to “underweight” from “middleweight,” citing its vulnerability to rising core bond yields.

“In South Africa, 2021 was a year of largely ‘good news’ — we see more risks in 2022, with FX most exposed,” JPMorgan emerging markets strategists said.

They noted that weakened support from terms-of-trade — a measure of a country’s export prices against its import prices — has driven the dollar back to year-to-date highs against the rand. As of Friday afternoon, the dollar would buy around 15.73 rands.

JPMorgan sees scope for further weakness, with the current account — which represents a country’s imports and exports of goods and services — expected to deteriorate in 2022.

As of September, South Africa’s current account surplus widened to an all-time high of 343 billion rand ($21.8 billion) on the back of a stronger trade account and record merchandise exports.

Gable disagreed with this prognosis, however, suggesting the tailwind from the country’s current account surplus will be more durable than expected.

“Part of [the surplus] is because commodity prices have been favorable. The mix of commodity price moves over the last couple of months has been a little bit less helpful to South Africa, but it doesn’t diminish the surplus that we expect to run going forward,” Gable said.

“That should provide, broadly, support for the rand even in an environment where globally, the world might be turning a little bit more against emerging markets.”

Absa expects a gradual weakening of the rand on a trend basis over the next two years, from a starting point at the end of 2021 of “somewhere in the early 15s to the dollar.”