The Reserve Bank still believes that a gradual increase in SA’s interest rates will be enough to keep inflation in check — but it cautioned on Thursday that this might have to change if the Federal Reserve moved faster than expected to tighten monetary policy and if global market conditions became more volatile.
This came as the Bank’s monetary policy committee voted four to one to increase the official repo rate by 25 basis points (bps) to 4%, as expected, raising its inflation forecast for this year sharply to 4.9% mainly on higher oil prices, and for next year to 4.5%.
But it warned that these forecasts might prove too optimistic in a global environment in which the risk of currency volatility and capital outflows had become more pronounced, and in which steep oil and electricity price rises posed short- and medium-term risks to inflation.
Though the rand has depreciated only 1.5% since the committee last met in November, and the Bank now believes it is trading at below its equilibrium level, there are still fears that markets could rapidly turn hostile if the US moves faster and more sharply than expected to raise interest rates and taper its monetary support if inflation keeps ramping up.
That could prompt outflows from risky assets in general and emerging markets in particular, putting pressure on the rand and SA’s inflation rate. Though the Bank’s “implied starting point” for the rand is now R15.60/$, some economists see the rand going significantly weaker than R16 before year-end.
The rate hike came in a week in which the US Federal Reserve signalled clearly for the first time that it would begin to normalise US monetary policy “soon” in the face of rapidly rising inflation — a signal that many in the market took to mean the Fed’s first interest rate hike would come in March. The Reserve Bank’s current model assumes, however, that the US will start monetary policy normalisation only in June, and governor Lesetja Kganyago said if the Fed acted sooner than expected that would have to be factored in.
“The committee 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. However, economic and financial conditions are expected to remain more volatile for the foreseeable future,” said Kganyago. While he emphasised that the Bank would “see through” temporary shocks and respond only if these fed through to higher inflation, he signalled the Bank would be watching the risks closely in an uncertain environment.
The Bank also lowered its growth estimate from 5.2% to 4.8% for 2021 and to 1.7% for this year, warning that with the global economy slowing, the economy couldn’t rely on exports as much as it had 2021 and would need consumer and investment spending to lift.
But it said its monetary policy was still “accommodative” and providing support to the eco-nomy, with the repo rate in real inflation-adjusted terms still negative, becoming neutral next year and positive only in 2023.
Most economists expect the Bank will move in lockstep with the Fed, implementing four 25-basis-point hikes this year, though the market is pricing in a sharper hiking path.
Deutsche Bank economist Danelee Masia said fourth-quarter growth figures and inflation basket revisions would have an important bearing on whether the Bank would hike again in March. “For now, we stick to the view that a pause is likely in March, to be followed by three more hikes this year (resuming in May), pending CPI revisions and near-term growth developments. Our terminal rate forecast is 5.25% in 2023, versus the Bank’s forecast of 5.8%. In our minds, the market should feel more settled about a 50-basis-point hike any time soon, but we will not dismiss the probability outright given a host of domestic inflation risks and global financial conditions.”
Absa economist Peter Worthington said: “The fact that the MPC vote was still split and that a 50bp hike was not even discussed supports our view that the market is being far too hawkish about the likely pace of tightening. We continue to forecast a modest pace of repo rate normalisation, with another 50bp of tightening this year, and 75bp next year, but some risk that these 25bp hikes could be somewhat front-loaded, depending on the data.”
Kganyago, who since 2017 has effectively targeted the 4.5% midpoint of SA’s 3%-6% inflation target range, called 2021
for the inflation target to be lowered, with speculation that he would like to see a point target as low as 3%.
The Treasury is leading a review of macroeconomic policy that will consider this, and Kganyago said the Bank would take its cue from that.
However, he said on Thursday: “Our inflation target is wider than the inflation targets of other inflation targeters and also higher than our peers and competitor countries, which means we are less competitive ... Lower inflation is in the best interests of the SA economy.”
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