Quite unfortunately, I have an “optimism bias”. I thought the global economy would defy the drag from US monetary policy tightening and maintain growth momentum. This view has now become difficult, if not impossible, to defend. The likelihood that the Federal Reserve (Fed) can get inflation under control without pushing the US and thus the global economy into recession is low.
While some commentators blame the war in Ukraine for food and fuel price shocks and recent inflationary pressures, the truth is that prices were already high before Vladimir Putin decided to invade. Inflation was already evident in the global economy generally and the US economy in particular. The enormous injection of liquidity into the global economy by the Fed, money drops by the Treasury and money drops by the IMF, caused the global economy to recover in record time.
The US now has high equity valuations, house prices, wages and inflation. The economy looks like it is overheating. Authorities won the war on GDP and stoked another on prices. The price issue extends beyond the US and could be seen in all commodities even before the Ukraine war.
The US core personal consumption expenditure (PCE) deflator, the measure of inflation targeted by the Fed, is expected to average 4.6% in 2022. This is well above the 2% targeted by the Fed. The federal open market committee’s policy stance and that of other central banks in emerging and developed countries are appropriately hawkish.
The SA Reserve Bank is expected to raise the repo rate by a quarter or half of a percentage point on Thursday, depending on who you ask. I expect the monetary policy committee (MPC) will choose to raise rates by half a percentage point to 4.75%, taking the total hikes from the inception of this hiking cycle to 1.25 points.
Remains low
The Bank’s quarterly projection model predicted that the repo rate would have to rise to just more than 5% by the end of the year and 6% by the end of 2023. For SA citizens, who must contend with moribund wage growth, and sky-high petrol prices and food prices that make you question eating as a necessity, these hikes add insult to injury.
There is little to suggest the SA economy is running hot. Inflation, while elevated, is concentrated in the more volatile food and fuel components of the basket. Forecasters expect the consumer price index (CPI) will remain at about 6% for the coming year and fall towards 4.5% in 2023. At 3.7%, core inflation, which excludes food and fuel and Eskom tariffs, remains low and is expected to remain below 4.5% this year. Services inflation is also at a low 3.5%. Excluding administered prices — prices set not by the market but by state entities — inflation is running at 4.3%.
Even then, the Reserve Bank needs to hike. As the governor often reminds us, its mandate is to target headline consumer price index (CPI) inflation, and this measure has been rising. If the MPC ignored the climb in CPI it would risk undermining inflation expectations. The Bank must be responsive to inflation pressures if it is to maintain policy credibility.
I was recently told by an offshore strategist that the SA Reserve Bank is the best emerging market central bank, and this is a sentiment widely shared by the investment community. The positive economic impact of this belief is difficult to quantify but is material. This is the credibility the Bank will act to defend.
However, the Bank has room for less aggressive tightening compared with other emerging markets and even, dare I say, the Fed. With soggy domestic demand, supply side-driven inflation could well be transitory. A positive current account remains a bulwark against a currency collapse. The risk of slowing global growth in the periods ahead is also something the MPC should consider when deciding how much pressure to apply on the brakes.
• Lijane works in fixed income sales and strategy at Absa Corporate & Investment Banking.
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.