When the Reserve Bank’s monetary policy committee goes into extensive detail on the inflation outlook in its post-meeting statement, you know it’s preparing to say something dramatic. So it was on Thursday, when the committee hiked interest rates by 75 basis points (bps).
That was more than most in the market were expecting. It was less than the preference of one member, who favoured an even steeper hike of 100 bps. Which is how you know the Bank is really worried about what’s happening to inflation, and more particularly to inflation expectations.
The theory is that monetary policymakers should not necessarily be responding to “first-round” spikes in food and fuel prices that they can do nothing about. Rather, they need to act, and firmly, when they see evidence that those spikes are feeding through to the behaviour of price- and wage-setters across the economy, becoming the “second-round” effects that risk prices spiralling and entrenching inflation.
In particular, they need to respond to the rising expectations of those very economic actors, in business, trade unions and the market, who shape price increases and bargain over wages. If their expectations are getting ahead of the inflation target range, it’s only a matter of time before inflation gets stuck there and becomes “unanchored” from the target. The danger, in other words, is that inflation becomes more permanent, not just persistent (or transitory).
We hear the cries of South Africans about rising prices and inflation eroding their wages and we are determined as the Bank to protect the incomes of South Africans.
— Reserve Bank governor Lesetja Kganyago
At this week’s meeting the committee was seeing clear evidence of all of those disturbing trends. Where at its May meeting it forecast headline inflation to stay just within target, at an average 5.9% for 2022 and 5% for 2023, now that’s lifted to 6.5% and 5.7%. More worrying is that core inflation, which excludes volatile fuel, food and energy prices, which previously looked quite muted, is now climbing rapidly towards an average 5.6% next year. And that’s the indication that price pressures are now becoming much more generalised and second round. Even more concerning is that inflation expectations have climbed, too. Then there are all the upside risks, from a weakening currency to global financial conditions that are getting tighter.
Most in the market had expected a 50 bps hike; instead the Bank went hawkish with 75, signalling clearly that it will do what it takes to get inflation under control sooner rather than later. It has the advantage that it started hiking before a lot of other central banks did in the face of rising inflation — and the fact that SA’s inflation rate is still significantly lower than the 9% plus of the UK and the US reflects that.
But the Bank clearly feels the “baby steps” 25 bps hikes of earlier meetings are no longer tough enough as the risk rises. That is the case despite a very weak economy — if anything it’s even because of a weak economy — as the risk the world fears now is “stagflation”, where economies get stuck in high inflation, low-growth cycles in part because they didn’t nip inflation in the bud fast enough.
Even at 5.5%, the benchmark repo rate in real, inflation-adjusted terms is still negative, taking into account forecast average inflation of 6.5% this year. That means, in the jargon, that monetary policy is still “accommodative” — that is, it is still relatively easy, and supportive of economic growth. It surely won’t feel like that to beleaguered consumers, hit by steep increases in the cost of living, as well as in the cost of borrowing.
But governor Lesetja Kganyago took particular care to emphasise this time the Bank’s price stability mandate is really about protecting people’s standard of living. “We hear the cries of South Africans about rising prices and inflation eroding their wages and we are determined as the Bank to protect the incomes of South Africans,” he said.
That framing of monetary policy is crucial to ensure broad buy-in for the Bank’s efforts to combat inflation. And while its hawkish stance is bound to generate much debate in coming days, if it can steer SA through the current crisis in a way that starts to bring inflation back into range without doing excessive damage to the economy’s already weak growth prospects, it will have been vindicated.
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