After the Reserve Bank’s monetary policy committee delivered a “hawkish hold” on Thursday, the question is what’s next. That could depend as much on what major central banks do globally as it does on SA’s own inflation dynamics. While most economists now believe SA’s interest rates have peaked, rate cuts are not expected before 2024, and possibly only late next year.
The Bank’s decision came in a week in which the US Federal Reserve (Fed) held rates but made hawkish noises. The models suggest it could hike rates again in 2023 if inflation pressures do not abate. The “higher for longer” scenario has become increasingly likely. The Fed’s hawkish comments prompted US government bond yields to climb to multidecade highs. Similar signals came from other advanced country central banks such as the Bank of England, which have left the door open for further rate rises if inflation doesn’t subside fast enough.
The signs are that growth in advanced economies is starting to slow, but that persistent inflation will keep rates higher for longer more broadly. That will tend to mean a stronger dollar and more risk-averse investors, who can earn high yields in advanced economies and don’t need to take the risk of buying emerging market assets.
For SA, it means the rand and bond yields will remain under pressure for external reasons. And SA’s deteriorating public finances and weak growth add to the pressure on the currency and borrowing costs, and could well keep monetary policy tighter for longer.
This is part of the context for the monetary policy committee’s Thursday decision. The “pause” people on the committee prevailed only narrowly, with two members of the committee favouring a 25 basis point hike and the Bank telling analysts on Friday that a 50 basis point hike had been discussed.
This is despite a somewhat improved inflation outlook, especially for core inflation, which is now forecast to come down quite rapidly. It’s also despite economic growth forecasts, which remain “muted” in the Bank’s words. So there’s little pressure on inflation from SA’s GDP growth, which the Bank now forecasts a fraction more optimistically at 0.7% for this year, compared to its 0.4% forecast in July, with forecasts for the next two years unchanged at 1% and 1.1%.
The Bank now forecasts average headline inflation for 2023 will be fractionally better at 5.9%, but fractionally worse for 2024 at 5.1% before stabilising at the 4.5% midpoint of the inflation target range in 2025. But it is not significantly more optimistic about the outlook for core inflation — the better measure for underlying inflationary pressures in the economy — which it now sees averaging less than 5% this year and over the next two years.
Yet the Bank is still worried about “persistent risks to the inflation trajectory” for at least three reasons. The global environment is one. Inflation expectations are another. Governor Lesetja Kganyago has made it clear the Bank is targeting the 4.5% midpoint of the inflation target range, not the whole range. He wants to see the target taken even lower.
Inflation expectations are key to that because of their importance in shaping the behaviour of price and wage setters in the economy. And while expectations have come down nicely in recent months, to about the 6% mark, that’s still well above the midpoint target.
SA’s fiscal risks are another big worry. With government revenue running well behind budget estimates and spending running ahead, next month’s medium-term budget statement will show a significant deterioration in the government’s deficit and debt metrics, with its borrowing needs and borrowing costs climbing in an increasingly unfriendly market environment. Such loose fiscal policy would generally mean monetary policy has to be tighter to counter it.
The prospect of other shocks, whether from global oil markets, geopolitics or the effect of weather on food prices, add to the Bank’s caution, as it does for central bankers everywhere. The Bank will be wary of signalling rate cuts anytime soon, and it has left the door open for further hikes if things go badly.
None of this is good for an economy as weak as SA’s. The latest round of bank results show consumers are clearly taking strain after a series of interest rate hikes that have been unprecedented in their speed and sharpness. Small businesses are taking pain too. The longer it lasts, the more the pain will increase. And while the Bank must be firm in its resolve to tackle inflation, it must take care not to overtighten and risk crushing what little economic growth there is.
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