Markets often fixate on an issue, and the ruling issue of concern now is inflation. Two years ago inflation was the lowest it had been in a generation. The script flipped in 2021, and the global economy is now dealing with the highest generalised inflation shock in a generation.
US inflation is expected to average 8% in 2022. For the UK, the number is 9.3%, the eurozone 8%, Brazil 9.6% and SA a relatively respectable 6.8%. Though inflation is likely to have peaked in most economies in June and July, celebrations should be delayed as price pressures seem set to remain at higher-than-comfortable levels for a while.
Inflation forecasts are still being revised higher, implying persistent underestimation of how difficult it will be to deal with the shock. For developed markets the pace of upward revisions is at about 0.4 percentage points a month, down from 0.8 points a month ago. For the subset of large emerging markets it is at about 2.4 percentage points, up from 0.7 points in August.
We cannot relax until expectations stabilise. Hot labour markets in developed economies, continuing Covid-19 lockdowns in China, surging energy prices in Europe, La Nina-induced drought in key food-producing regions and other climate catastrophes will continue to put pressure on inflation. The production cut announcement by Opec could prop up the oil price, undermining a key disinflationary element in the global economy.
Global monetary authorities cannot afford to blink lest they stoke a more enduring inflation problem further down the line. Central banks have struggled to keep up with worsening inflation outcomes, even as they have accelerated the pace of tightening. Real rates have become more negative, implying less tightening of financial conditions compared to what is required.
The European Central Bank is expected to raise rates a record 75 basis points at its meeting this week, and the market is betting on hikes of similar magnitudes for the US and UK later this month. Most central banks that meet before the Reserve Bank’s September 22 monetary policy committee (MPC) gathering are expected to raise rates, many by large increments.
In SA, inflation came in at 7.8% in July. The last time it was this high was in 2008/2009, and before this in 2002/2003. This inflation rate was well above the upper end of the Bank’s inflation target of 6%. The expectation is that inflation has peaked and will drift into the target range by the second quarter in 2023.
However, forecasters have increased their predictions by about 0.2 percentage point over the past month. If upward revisions continue, as they tend to, the move into the target range could be delayed. This is the environment in which the MPC will meet.
The market is discounting another 75 basis point hikein September. Forward rate agreements project that the repo rate will rise to 8% in the next year, a level well above the Bank’s 2024 forecast of just under 7%. The market tends to be more reflective of global risks than the Bank, and so far it has been right.
Though the Bank must maintain some congruence with a more hawkish global setting, there are domestic factors that support less aggressive tightening. At some point the fact that the domestic economy is far less risky should hold sway.
The SA economy is not overheating, a factor that makes it distinctly different from developed economies. Food price pressures should and are moderating. The rand, while weak relative to the US dollar, is resilient against other currencies, especially the euro. Higher non-oil fuel prices have been supportive to coal, keeping a floor under the terms of trade.
This economy, unlike many emerging markets in debt distress, borrows relatively little in hard currency. All of these factors, while not negating the consequences of a global inflation melt-up, mean the Reserve Bank might have room for less aggression.
• Lijane works in fixed income sales and strategy at Absa Corporate & Investment Banking.
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