There was some shock that the SA Reserve Bank didn’t cut rates at its monetary policy committee (MPC) meeting last week. With the economy barely growing, consumer inflation in retreat and major central banks in cutting mode, it’s becoming harder to explain to an embattled nation how the Bank can remain unmoved.
A few economists had expected the Bank to cut the repo rate to 6.25%. Many thought that at least a few MPC members would vote for a cut. Instead, the decision to hold was unanimous.
This seems surprising given that monthly inflation is largely anchored around the mid-point of the target range (4.5%), the Bank cut its growth forecasts, its inflation forecasts are benign, and inflation expectations continue to moderate.
In fact, expectations have been falling steadily for three years. Meanwhile, consumer inflation has remained inside the target band for 28 straight months, since April 2017 — almost the longest period on record. For 70% of this time, it has been between 4% and 5%.
This is quite an achievement. It’s been possible partly because the economy and household disposable income has been slowing, reducing firms’ ability to pass cost increases onto consumers. It’s also possible that this, coupled with technological advances, has made firms permanently leaner and more efficient. If so, these gains could be sustained.
Credit must also go to the Bank for its clear, consistent messaging in recent years that it is determined to steer both inflation and inflation expectations from 6% towards 4.5%.
Bank governor Lesetja Kganyago believes the Bank was too dovish after the global financial crisis. By ignoring the bottom half of the target band and tolerating inflation around 6%, it created the impression that the inflation target was 6%, he says.
The upshot was that inflation and inflation expectations became sticky at the top of the target band. Worse, indexation set in — prices and wages were locked in to grow at 6% each year — so inflation didn’t fell much, and nominal interest rates remained structurally high.
The Bank realised that the only way SA could have permanently lower interest rates was if it had structurally lower inflation. One way to better achieve this was to be clear about where it wanted inflation to be — at 4.5%. But if the Bank has more-or-less achieved the 4.5% target and has got inflation expectations to moderate, why didn’t it cut rates last week?
Anchoring inflation expectations
There are two main reasons. The first is that the MPC is not convinced that these gains are sustainable. It wants to see inflation expectations anchored sustainably at 4.5%. Measures of expected inflation for 2020 and 2021 remain around 5% and, given that consumer price index (CPI) is set to average 5.1% next year, it’s clearly too soon to cry “Victory!”
The second factor relates to “persistent uncertainty”. Internationally, the Bank is worried about escalating trade and geopolitical tensions and higher oil prices. Domestically, it’s worried about the impact on the rand of SA’s faltering growth prospects and rising fiscal risk because of the knock-on effect this would have on inflation.
The markets are likely to hate the medium-term budget on October 30 since it will show a severe deterioration in SA’s debt metrics and a big rise in its borrowing requirements. The rand and government bond yields could take a hit, especially if this is followed by a ratings outlook downgrade from Moody’s, or if there is continued policy inertia on Eskom and broader state-owned enterprise restructuring.
The bottom line is that the Bank is unlikely to cut rates until it sees material progress on both these fronts. This suggests that rates could remain on hold for at least another year.
This is not the Bank being overly conservative; it’s the Bank ensuring that low and stable inflation is sustained — which is its job, after all. Given the way the rest of the government is behaving, SA should be grateful that at least one institution is unafraid to make hard, unpopular decisions.
• Bisseker is a Financial Mail assistant editor.
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