Amid surging commodity prices the Reserve Bank is unlikely to respond to heightened inflationary risks by raising interest rates more aggressively, and is expected to stick to the pace of normalisation it adopted during its last two meetings, economists say.
The monetary policy committee, which in the wake of the Covid-19 outbreak reduced the repo rate to a record low 3.5% to aid recovery, will be mindful of the need to cushion an economy still below its level before the pandemic, as well as the coming hit to consumer confidence and spending from record petrol prices. The repo rate is 4%.
“Aggressive rate hikes are not necessarily the correct response to a big stagflationary shock,” said Absa chief economist Peter Worthington, describing a situation of persistently high inflation coupled with high unemployment and slowing growth. He expects policymakers, who start a three-day meeting on Tuesday, to increase rates by 25 basis points, as they did the last two times they met.
Russia’s invasion of Ukraine and sanctions on the country have sent commodity prices soaring, leading to direct adverse implications for SA’s headline consumer price index (CPI). Higher oil and grain prices have directly pushed up prices of goods in the CPI basket, such as fuel and bread, resulting in a revision of SA’s inflation projections.
The Treasury said last week it had revised upwards its inflation expectations to 5%-5.5% in 2022 compared with the 2022/2023 budget projection of 4.8%. The latest Thomson Reuters Econometer poll for SA also showed marked upward revisions to consensus inflation projections for 2022, with headline inflation now projected to average 5.5% in 2022, up from 5.0% in February.
Absa raised its forecast for CPI, which it now expects to average 5.9% in 2022, close to the upper end of the central bank’s 3%-6% target range. The forecast is subject to downside risks given the volatility and unpredictability of oil prices, the bank said. Last week the price surged towards $140 a barrel, and then slumped below $100, partly on concern that a Covid-19 outbreak in China would further slow the global economy and hit supply chains.
Nedbank senior credit research analyst Jones Gondo said the central bank is likely to act this week to avoid higher inflation expectations becoming entrenched.
“The SA Reserve Bank is focused on anchoring inflation expectations lower at 4.5% as opposed to close to the upper end of the target band. Consequently, they need to respond to reining in expectations and ensure that core inflation remains stabilised,” Gondo said.
“As a result, we think there will be a 25 basis points hike. ”
Rate hike fears in SA were worsened by the US Federal Reserve (Fed) increasing its main rate by 0.25 percentage points on Wednesday, the first increase since December 2018. Higher interest rates in developed markets have the potential of drawing capital away from riskier assets such as SA bonds, which may then put pressure on the rand, further increasing the price of imported goods such as oil.
In the midst of the turmoil, the rand has been among the most resilient emerging market currencies, holding on to gains that pushed it to four-month highs below R15/$ even after the Fed and Bank of England (BoE) raised rates. While the inflation outlook will worsen due to oil and food prices, the currency is providing support. SA’s currency has gained as the conflict in Ukraine boosted the prices of commodities that the country exports.
Maarten Ackerman, chief economist and advisory partner at Citadel, said if energy prices and oil prices continue to increase, there could be a global recession. That, economists said, could be an argument against faster rate increases as inflationary pressure is unlikely to come from consumer spending.
“That’s because higher commodity prices, higher inflation, especially higher oil is obviously going to take money out of consumer pockets, putting a stop to consumption and affecting demand-side growth,” Ackerman said.
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