May’s consumer inflation number came in at 5.2% again, the same as in April. Core inflation is not far above the midpoint of the target range at 4.6%. Food inflation has come down nicely, from highs in the double digits to the latest read of just 4.3%.
The latest numbers were in line with market expectations. They are looking good to support a first interest rate cut, which the market now expects could be in September. And the rand’s recent strong rally could provide the necessary comfort for that, if it is sustained. The currencies of many of our emerging-market peers have been taking pain at the prospect that the US Federal Reserve will keep rates higher for longer, a prospect that has driven the dollar surprisingly stronger.
Emerging-market currencies have suffered their worst start to the year since 2020, with JPMorgan’s emerging-markets foreign exchange index down 4.4% so far this year, a drop more than twice as large as the same period in the past three years.
For once, though, SA’s political prospects have prompted the rand to outperform, with it breaking through R18 to the dollar last week. Foreign appetite for SA’s local currency bonds is reviving, too, as investors respond enthusiastically to a government of national unity (GNU) that seems better than even the best case many had expected.
As always though, risks abound — at home and abroad. The GNU may be in place, but the cabinet to put it into effect in ways that stand to make a real difference to SA’s economic performance is not, at least not yet.
The weekend brought disturbing reports of tensions between the DA and an “arrogant” ANC, which appears unwilling to accept its minority status and give up significant power to the GNU’s founding partners, the DA in particular. The rand could respond quite quickly, and not in a good way, if President Cyril Ramaphosa is not willing to make some big decisions and opt for the bold compromises that will be required. That, in turn, could put the inflation outlook at risk again.
Then there is the global picture, which is as interesting and uncertain as ever. Inflation spiked in 2021 and 2022 as the global shocks first of Covid-19’s aftermath then of Russia’s invasion of Ukraine drove up prices globally. But inflation has been subsiding rapidly across the globe.
Latin American countries were the first to start hiking interest rates back in 2021 and they were therefore able to start cutting first. But advanced economy central banks are increasingly joining the cutting cycle, too. The Swiss central bank was the first to cut, in March; now the Bank of Canada and, significantly, the European Central Bank, have implemented their first interest rate reductions.
But the key one to watch when it comes to global financial conditions is the US Federal Reserve. Markets are also closely watching the Bank of England (BOE).
And just as politics is a key factor lurking in the background of monetary policy decisions here, so in a different way it is in the US and UK. Both face landmark elections, and their central banks will want to be seen not to be favouring incumbent political parties by cutting just before the elections.
In the UK, the BOE last week kept rates on hold ahead of the July 4 election, which is all but certain to install a Keir Starmer-led Labour government, probably with a landslide. In the US, though inflation data might suggest scope for a first rate cut at the Fed’s September meeting, which is the last before the November 5 election, the Fed might hold back. Nor is it just the politics: there are still question marks over whether the US economy has cooled sufficiently to set the stage for the cutting cycle to begin. If the Fed waits longer, even until next year, and keeps rates higher, dollar strength could continue to weigh on emerging-market currencies, including SA’s.
Step back and look at the inflation big picture though, and there are big lessons that the world has learnt over the past four years — lessons about the power of sound monetary policy to prevent inflation spiralling across very different economies in response to global shocks. The inflation targeting policies that central banks around the world have adopted in the past two decades or more prevented inflation expectations, and inflation from getting out of control despite the shocks, and enabled it to be reduced without recessions.
As Peterson Institute president Adam Posen wrote recently: “Independent central banks and low and transparent inflation targets are a killer combination.” It’s an important reminder for the GNU too.
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