Given the flurry of activity for the Reserve Bank in 2020, it seems odd to describe the monetary policy committee that started on Tuesday as the most interesting in a while.
After cutting the repo rate by 100 basis points to 5.25% in March 2020, the Bank was moved by the pandemic to hold an unplanned meeting in April, cutting the rate by another percentage point. In July, it fell to 3.5%, the lowest official interest rate in about five decades.
Given the unprecedented nature of the shock, these moves seemed almost “normal”. If there was any controversy it came from those who insisted that Bank governor Lesetja Kganyago was not doing enough to help an economy in distress, and called for unconventional policy measures such as quantitative easing.
Under normal circumstances, economists debating whether the repo rate should be increased by 25 basis points this week would seem pedestrian.
But this meeting is happening at a time when global central banks are grappling with a resurgence in inflation and in the midst of debates about when they should start making policy for a more normal world. This, in turn, has implications for SA and demand for local assets, which could affect the rand and future inflation.
Writing in the Financial Times, Canadian central bank governor Tiff Macklem echoed sentiments in a Business Day editorial that policymakers are facing a delicate communication challenge as they seek to restore their inflation-busting credentials while securing the economic recovery. His counterpart at the Bank of England, Andrew Bailey, has attracted the wrath of investors for having signalled, and then not delivered, higher interest rates.
SA has so far benefited from prior prudence that kept inflation within target and secured the credibility of its policy. The repo rate is where it was at the height of the crisis, while Brazil and Russia have increased theirs. Turkey, where policymaking is chaotic and marked by political interference, is expected to cut rates, adding to 300 basis points of reductions since September. That has been done despite an inflation rate of about 20% and a currency that plunged to record lows.
The growing consensus among analysts is that other emerging markets will raise rates. The main driver is the prospect of tighter policy in developed markets that will draw capital away. Higher oil prices, weaker currencies and surging food prices amid Covid-19-induced supply bottlenecks have pushed inflation higher.
In SA, the headline rate is at 5%, near the top of the 3%-6% target range. An argument can be made that a weak economy and unemployment rate of just over 34% means there is no danger of consumer demand running away, and that the factors driving inflation cannot be controlled by interest rates. Core inflation, which excludes food and energy costs, is running below the midpoint of the target range.
While central banks have in the past emphasised the forward-looking nature of policymaking, their more recent signals have been that they are watching developments and have tools to respond if inflation turns out to be entrenched. They are reluctant to take pre-emptive steps that may stop the recovery. In SA, there is no evidence yet that faster inflation is here to stay.
An argument has been made that an inflation rate of 5% has left SA with negative real rates that will hurt the currency. But then, who does not have negative real rates? The US inflation rate is running at over 6% annually, compared with a federal funds rate of zero to 0.25%. The Federal Reserve is tapering bond purchases but rate hikes are still not on the horizon.
Money markets are pricing in a 25 basis points increase in the repo rate but economists are sufficiently divided for Kganyago to get away with “disappointing” markets without economists saying he bottled it. Two months ago, deputy governor Kuben Naidoo suggested that even if the Bank raises rates, policy would remain accommodative because the so-called neutral rate is about 7%. That will provide nice cover if the Bank moves and is attacked for doing so.
It probably should stay biased towards securing economic recovery and stay put on rates. But it’s a tight call.
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