“Adventurism is not part of our monetary policy toolkit,” declaimed Reserve Bank governor Lesetja Kganyago after the monetary policy committee (MPC) finally implemented a first, cautious, 25 basis-point cut to its repo rate on Thursday.
One had to wonder whether the governor found US Federal Reserve chair Jerome Powell’s 50 basis-point cut a little adventurous for his taste. Certainly, the cutting cycle the Fed has now kicked off is a lot bolder than the one the Bank has in mind.
The Fed’s estimates are for another 50 points this year and a cumulative 200 basis points (bps) in the next two years. The Reserve Bank’s model sees a cumulative total of just 100 bps points in the next two years. That would bring SA’s benchmark repo rate to 7.25% — still far higher than the 6.25% at which it stood on the eve of the Covid pandemic. The market expects a slightly bolder 125 bps of cuts, but that still only brings the repo back to 7%.
Indebted consumers and businesses are not going to say no, but why so shallow a cutting cycle? SA never had to hike as much as the Fed and other advanced economies because it started hiking earlier and inflation didn’t go as high. Still, it’s not going to cut as much either — even though inflation has been coming down faster than expected after a sticky start, and many of the concerns have subsided, including the Fed itself.
The Fed’s cuts should help raise international investors’ risk appetite and drive capital flows to emerging markets such as SA. That should help support the rand, over and above the big gains the currency and local bonds have made since the government of national unity was installed — and that, in turn, should be benign for inflation. So too will lower food and fuel prices. Inflation expectations are coming down, so that could feed through to lower price and wage demands.
All of that lowers the inflation trajectory over the next couple of years. And the Bank’s more benign inflation outlook captures that. It slashed its forecast for this year’s average to 4.6% from 4.9%, coming down to 4% next year — below the midpoint of its 3%-6% target band. All of which could justify a more robust cutting cycle, especially since some economists believe disinflation could be even faster.
Yet Kganyago on Thursday made much of the risks, external and internal, and the need for caution, in a 30-minute press conference in which he took pains to make clear the MPC’s decision had been unanimous. It seemed counter to the Fed excitement the previous evening, and to market speculation of late that SA, too, could do 50 bps.
Yet SA’s structurally low growth and structurally high inflation are a big part of the answer to why so shallow. Unlike the Fed, which seeks to support a strong labour market even in a robust economy, the Bank is contending with a weak economy and even weaker labour market, which can’t be fixed by monetary policy. So its main focus now is on “normalising” interest rates as inflation comes down, rather than on providing cyclical stimulus for the economy.
Lower interest rates will help the economy to some extent in the shorter term. But no amount of cutting will address the structural woes ailing the economy and keeping what economists call the potential growth rate low.
The potential or trend growth rate is the rate the economy can sustain without running into inflationary pressure. The Bank’s estimates show that potential has jumped from 0.2% last year to 1.2% now, thanks to the halt in load-shedding.
But that’s still incredibly weak; ratings agency Fitch now estimates potential growth at an even gloomier 1% for the next five years. At least the Bank sees potential growth climbing to 1.8%. But for central bankers it’s only when actual economic growth falls well below potential that interest rates become a tool to boost the economy without causing inflation.
In SA’s case, sadly, there’s hardly an output gap to be closed because both it and the economy are so weak. Only structural reforms can turn that. Which is why the Bank is looking only to bring rates back to what it estimates is the “neutral” or normal level — at which they neither stimulate nor contract the economy — which is around 7%.
But crucially, the expected shallow cutting cycle is also about what one economist called structural reforms to SA’s inflation rate. Kganyago made that clear on Thursday when he said: “What the economy needs is not just lower inflation. It needs low and sustained inflation.”
He has long argued for a lower inflation target, suggesting 3% would bring SA in line with its emerging market peers and make it more competitive, thus helping to boost growth and jobs in the longer term. The target is set by Treasury, in consultation with the Bank. The Treasury has said it will review the target but few expect this to be a priority battle finance minister Enoch Godongwana wants to fight.
That doesn’t mean the Bank can’t just do what it did in 2017: gradually message the target down from the 6% top of the range to the 4.5% midpoint. Its research shows it managed to do that largely without sacrificing economic growth. Gradually shifting expectations towards the bottom of the range could be a harder sell.
But if inflation comes down further and faster than expected, it could be easier, and it could put pressure particularly on the government to curb the runaway price pressure in electricity, water, rates and the like which together are a big factor keeping SA’s inflation rate structurally high.
The rand may have strengthened and could continue to do so if SA’s political and fiscal risks recede. But as the governor noted, as long as SA’s inflation rate is so much higher than that in the US the currency will be at risk of depreciation. That’s especially so if global markets turn unfriendly again for whatever reason.
US politics could be one of those reasons. A Donald Trump win in November’s presidential election and the trade wars that could follow would tend to drive up inflation — and prove Powell to have been too adventurous. There are so many reasons to hope that won’t happen.
• Joffe is editor-at-large.
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