Global monetary policy expectations have shifted towards interest-rate cuts in 2019, from expecting a pause earlier in the year and hikes as recently as December 2018.
This week the US Federal Reserve kept its targeted interest rates unchanged at 2.25%-2.5% and gave its strongest indication since he financial crisis that it will probably cut rates due to rising uncertainty about the outlook on economic growth, labour markets and inflation.
The shift from patience in assessing economic data to inform appropriate policy action signals that the Fed will probably cut rates at its next meeting on July 30-31, if not at the September 17-18 meeting. The latter is associated with the release of a summary of its economic projections to justify the move.
The change in the Fed’s stance on cutting rates strengthens the case for the SA Reserve Bank to cut interest rates at one of its next two monetary policy committee meetings, on July 16-18 and September 17-19. Let me walk through the case for cutting rates.
The contraction in economic growth in the first quarter was so deep that for the economy to grow close to the now possibly outdated Bloomberg consensus estimate of 1% this year, quarterly annualised growth must average at least 3% for the next three quarters.
We are halfway through the year and the economic policy framework is still muddied by politics. Perhaps miracles can still happen, but economic growth is not an outcome of miracles so the odds are that it will be another year of sub 1% economic growth, following 2018’s 0.8%.
Headline inflation came in at 4.5% for May, averaging 4.3% in the first five months of 2019. In fact, inflation has been at or below the 4.5% mid-point of the Bank’s target band of 3%-6% for the past six months. So it has kept inflation around its desired level, mid-point of the range.
The Bank’s inflation forecast at its May monetary policy committee (MPC) meeting was exactly 4.5% for 2019, before rising to 4.9% in 2020 and moderating to 4.6% in 2021, still within its preferred 1.5 percentage point deviation from the mid-point.
Historically, inflation outcomes have little role in setting interest rates, but play a role in the formation of inflation expectations. For the Bank, inflation expectations are a big deal. It has succeeded in reducing inflation expectations, as measured by the University of Stellenbosch’s Bureau for Economic Research – current, one and two-years out – from 11%, 8.7% and 7.9% respectively, to 4.8%, 5.2% and 5.3% as of the first quarter of this year.
Five-year inflation expectations have also moderated, from a high of 6.3% in the fourth quarter of 2011 to 5.1% in the first quarter of this year. This is a huge success for the Bank, deserving of celebration. The Bank needs to be supported to continue pushing these expectations lower towards the desired outcome of anchoring them around the target band’s mid-point of 4.5%.
While the Bank has been largely successful in pushing inflation expectations lower, the same expectations could be used to argue for not cutting rates. It took the Bank almost 12 years from the third quarter of 2007 to push current year, one-year and two-year inflation expectations to their current lowest levels of 4.8%, 5.2% and 5.3% respectively.
What is the likelihood of these inflation expectations rising if the Bank cuts rates? I am not sure about the answer to this question but I am sure the Bank will have to consider seriously the risks in undoing its hard work over a decade. A cut of no more than 50 basis points will after all have little direct effect on economic growth, other than boosting consumer confidence.
That said, the Bank may need to send a message through a confidence-boosting 50 basis point cut, perhaps not at the July meeting because that could be viewed as succumbing to political pressure. The September meeting seems more conducive as it will happen after the Fed meeting, providing a lot more global context without the baggage of fearing for its credibility, given mounting political pressure.
• Mhlanga is executive chief economist at Alexander Forbes.
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