MAMOKETE LIJANE: Reserve Bank’s legendary caution comes at a cost

Before the current easing cycle started I thought the Reserve Bank might cut rates by 1.5 percentage points, so the repo rate would move from 8.25% to 6.75%. I thought inflation would bottom at a level materially lower than what the monetary policy committee (MPC) was forecasting, and this is exactly what happened.

As 2024 progressed, inflation outcomes continuously surprised to the lower side. Core inflation was depressed by a stronger rand and lower goods prices. My favourite example of this phenomenon is car prices, for which inflation here has fallen to a mere 2.9% from 8.5% in August 2023. 

Base effects of load-shedding in 2023, rand weakness into the second half of the year, and oil price increases into October last year have also worked to collapse inflation. The Bank consistently revised its inflation forecast lower over 2023. In March, consumer inflation was seen at 4.7% by the end of this year, and it is now expected to average 3.2%. 

By contrast, the forecast path for the repo rate is little changed. The Bank’s model forecast in March that the repo would bottom at 7.37% at end-2025. The model now forecasts 7.4%. The reason for this is the deterioration in inflation beyond the current point and especially into 2025. Low inflation now creates the base for higher inflation a year hence, which has served to undermine inflation forecasts.

The outlook is further worsened by electricity tariff increases. In its latest application Eskom is asking energy regulator Nersa to approve a tariff increase of up to 36% next year, which if approved would unmoor the inflation trajectory into the end of 2025. The Bank has assumed Eskom will only be allowed about 16% next year. That is enough to push the consumer price index (CPI) increase forecast above 4.5% in the second half of the year. Even as the CPI reached 2.8% on latest figures, end-2025 inflation forecasts have started to tip up, causing end-2025 repo rate forecasts to inch higher. 

The Bank first forecast that inflation would reach the 4.5% midpoint of its target range in May, but decided not to cut then because it wanted to see inflation at 4.5% for longer. Inflation forecasts continued to collapse into July, but worries had then moved to offshore dynamics and risks to the rand. Inflation continued to slow faster than expected, and the Bank started easing in September.

The timing matched that of the US Federal Reserve. Yet, moves were carefully calibrated at 25 basis points (bps) per meeting, compared with the Fed’s initial 50bps move. The MPC’s stated objective was then, and continues to be, to move rates to the neutral level around 7.25%, consistent with another 50bps in cuts into the middle of next year.

I now suspect the space for more easing has closed. With current inflation dynamics, cutting beyond 7.25% now looks reckless. By the MPC’s own admission, monetary policy remains tight and a policy rate of 7.25% would only be neutral as opposed to easy. Meanwhile, the economy is smaller than it could be without causing undesirable effects.

In economic speak this is called a negative output gap. The Bank estimates that this gap will only close in 2027. Policy is never calibrated perfectly for any economy, and central banks are risk managers by nature. The Bank has typically been cautious about inflation, but maybe it should also be more worried about growth.

Arguably, the MPC could have given the economy support by starting to cut earlier and faster. By delaying cutting, the Bank erred, running policy tighter than should have been the case. Its caution is legendary and is one of the anchors of the country’s macroeconomic stability, but it comes at a cost. 

• Lijane is global markets strategist at Standard Bank CIB.