One of the more interesting observations of the Reserve Bank’s decision to raise SA’s borrowing costs for the first time in three years came from a person in the market who pointed to the global context in which it happened.
How is it, the person wondered, that developed economies that have staged faster recoveries both in GDP growth and employment have been so desperate to keep interest rates on hold near record lows, and yet SA is eager to do the opposite?
Not only is SA saddled with a record unemployment rate of more than 34%, the economic expansion is expected to slow rather dramatically from 2022. Unlike those economies, SA’s inflation rate, based on the central bank’s forecasts, will stay well inside the 3%-6% target range through to the end of 2023.
For context, the annual inflation rate in the US jumped to 6.2% in October, well above the 2% target. And yet the central bank of the world’s largest economy is unlikely to be raising interest rates until at least the middle of 2022. The head of the Bank of England recently got into trouble for mixed messages on when UK rates would rise in response to inflation that’s running at more than twice its target.
North West University Business School economist Raymond Parsons described the arguments put forward by the Bank for raising rates as “not persuasive”, given its own comments about the outlook for inflation and GDP growth. He also pointed to the time lags in monetary policy, which means the impact of last week’s hike will most likely be felt in 2022 and 2023, when the central bank expects the economy to have slowed from the temporary surge of 2021.
When there are contested decisions, as seen in the past week, the focus does quickly turn into whether the central bank could have done better in its communication. It was the same in January 2020, when rates were cut. If economists were evenly divided this time, it was the opposite then. According to a Reuters poll ahead of that meeting, 21 out of the 24 analysts expected the repo rate to stay unchanged.
There was an interesting article in the Financial Times in the past week that characterised the debate about the inflation outlook as one between two sides, with leading economists and central banks still to have sufficient consensus. The question that the Bank has perhaps not addressed adequately is whether it’s on “team transitory” or “team permanent”.
On one side, there is an argument that the spike seen in consumer prices has been caused by extraordinary factors due to the opening up of economies after the Covid-19 lockdowns. With workers in developed markets having spent months at home but still getting paid through generous furlough schemes, they’ve now come back ready to spend their excess savings, while supply chains disrupted by Covid-19 haven’t caught up.
There are other temporary factors such as surging fuel prices that will also not last. According to this side, central banks risk a huge policy mistake if they act too soon. And, in any case, interest rates are unlikely to have an impact on these short-term supply shocks.
For the other side, if they wait too long, then the current inflation will get embedded and they will lose credibility. Already here in SA, we are seeing what could be the beginnings of a period of labour instability, with companies including Massmart and Tiger Brands facing actual or threatened industrial action, with workers demanding above-inflation settlements.
Public statements on where the Bank stands have been a bit mixed, to say the least.
It was not that long ago that Bank governor Lesetja Kganyago signalled during a panel discussion with the Bank of International Settlements and the US Federal Reserve that he didn’t think central banks were behind the curve. He indicated that it would be a mistake to act pre-emptively and damage the economic recoveries.
Based on those comments, one would have placed him on “team transitory”. But he did also say that “there is no question if the rise in inflation is persistent and not transitory, then we will have to adjust”, and that policymakers would have to “act with resolve” if faster inflation proved to be persistent.
Did enough change between that statement on October 22 and last week’s monetary policy committee to suggest the danger of being behind the curve had become more real? Since the Fed reviewed its policy, when inflation was running below target, and said that it would act only after the annual rate had averaged 2% on a consistent basis, policymakers have given the impression that they were more backward than forward looking.
So, desperate not to act too quickly, they’ve placed emphasis on actual evidence of inflation persisting above target rather than acting based on where they think it will be further down the line. And this has made their intentions more difficult to read.
Perhaps, rather than its argument not being “persuasive”, the problem is that it doesn’t make a forceful one either way, merely describing circumstances and risks, and then saying “against this backdrop” it has decided one way or the other. Despite that “backdrop”, two members voted to stay on hold last week, so the call could easily have gone the other way on a single vote.
Reading the statement overall, it’s hard to get an explicit sense that the MPC was panicked into acting by anything that changed between meetings, with adjustments to its inflation outlook being rather small.
But “team permanent” seems to have the upper hand.
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