The decision by the Reserve Bank’s monetary policy committee (MPC) to hold the repo rate steady at its July meeting was “risky”, and tight monetary policy might see the economy enter a recession down the line, Investec Wealth & Investment chief investment strategist Chris Holdsworth has warned.
Holdsworth, who is responsible for investment strategy, said that monetary policy could soon be at its most restrictive in almost two decades.
Keeping interest rates unchanged “was a risky move given the improved inflation trajectory. The MPC now expects inflation to be below the midpoint of the range for three consecutive quarters from the fourth quarter this year. Our forecasts are slightly lower than the MPC’s — we expect inflation to be below 4% by October,” he said.
“The market expects three to four cuts of 25 basis points each over the coming 12 months. Even so, if the Reserve Bank’s inflation trajectory is correct that will still lead to the most restrictive monetary policy in 19 years by year end (with inflation expected to be below the 4.5% target).
“That poses two risks: first, the MPC could put SA into recession, even with inflation in line with or lower than the middle of the band; second, there could be damage to the central bank’s credibility given unnecessarily tight monetary policy.
“It is not clear what threat to inflation the MPC sees to justify taking these risks. Nonetheless, deferring a rate cut may simply mean a greater need for accelerated cuts later.”
Economic theory suggests that if tight monetary policy seeking to reduce inflation goes too far, it may push aggregate demand so far down that a recession begins.
Two of the five MPC members voted two weeks ago for a 25 bps cut, suggesting the committee’s next meeting in September might herald the beginning of the monetary easing cycle. The MPC highlighted that maintaining a restrictive policy stance is necessary to stabilise inflation at the Bank’s 4.5% target, emphasising that keeping interest rates unchanged is appropriate in light of existing inflation risks.
Old Mutual chief economist Johann Els, who was advocating for a cut, has said lack of forward-looking policymaking was a concern.
Inflation target
There has been growing noise around realigning SA’s inflation target to the low end of the target range.
“I also thought that the Reserve Bank should have cut rates in July. I don’t agree with the argument that we should wait for the Fed before we can cut. The local fundamentals are such that interest rates should be cut. Underlying inflation has fallen substantially. Even though headline inflation is still at 5.1%, consumer goods inflation is at 3.5%; inflation excluding petrol prices is at 4.6%,” Els said.
“I think our central bank should be more forward-looking instead of focusing on the past. Forward-looking we are going to see further declines in actual inflation. I agree with the two members of the MPC that voted for rate cuts. We don’t need to wait until inflation is at 4.5% before we cut rates.
“We don’t have to drive consumers into recession conditions before we cut interest rates. By not having cut rates, we risk a policy error,” he said.
North West University Business School economist professor Raymond Parsons said the minority view at the latest MPC meeting confirmed that recent economic data had now created room for legitimate differences of opinion about when to start cutting interest rates.
“While the MPC majority vote opted for caution in the face of uncertainty, the data dynamics are now tipping the scales towards an initial reduction in rates at the next MPC meeting. September should see a shift in economic perceptions,” he said.
“There is much better news on the inflation front and we are close to reaching the 4.5% target. Given the time lags with which monetary policy operates, a flexible stance is now required from the MPC if low and stable inflation is to serve the interests of balanced and sustainable growth. Global experience has shown that a central bank can hit its inflation target for the wrong reasons, as well as miss its target for the right ones,” Parsons said
Most pundits now expect the MPC to cut interest rates at its September meeting.
The July meeting marked the seventh consecutive time the MPC left the cost of credit unchanged. The prime lending rate has risen 475 bps since November 2021 to 11.75%, which is 200 bps higher than a few months before the Covid-19 pandemic erupted.
SA banks have over the past two years been in a profitability sweet spot, as they benefited from rising rates due to what is called the endowment effect. This happens when interest rates are rising and banks make more money as expressed through the net interest income line on the income statement.
However, the other side of this leads to consumers struggling to keep up with payments and banks reporting increased bad debts.
Nedbank and Standard Bank have said they expected the MPC to start cutting rates at its September meeting.
SA’s economy narrowly escaped a technical recession in the fourth quarter of 2023, after expanding 0.1% in that quarter.
The CEO and founder of SA’s biggest asset manager, Ninety One, Hendrik du Toit, has hailed the monetary policy management skills of the Reserve Bank, saying that the central bank was ahead of the curve on interest rates, which led to market stability.
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