Do the monetary policy committee’s (MPC’s) decisions depend on the data and its own forecasts? Or do its members depend instead on their perceptions of political and geopolitical risks?
Last week’s MPC meeting set up a very clear tension between the two approaches. In theory, as Reserve Bank governor Lesetja Kganyago frequently points out, the committee’s role is precisely to assess the risks, rather than to depend mechanically on the models. In practice, the latest meeting set this up as a stark dilemma.
On the one hand, the outlook for inflation is looking particularly benign in the short and the medium term. On the other hand, the world is looking “extremely uncertain”, as the opening line of the committee’s statement put it, with multiple moving parts. Based on its own, improved inflation forecasts, it would have been hard for the committee to justify holding interest rates again. That would certainly have been the view of the two members who preferred a 25 basis point cut. But the other four fixated on upside risks, international and domestic, and in the medium term, not the short term. They took the path of extreme caution. And they prevailed.
That means that SA has had one of the shortest and shallowest rate-cut cycles yet. It began only in September 2024. So far we’ve had just 75 basis points of rate cuts, to bring the benchmark repo rate down to 7.5% — well above its pre-Covid-19 level. Several economists now expect that 7.5% is where the repo will stay, with no further rate cuts. Even if the committee does take the gap next time, if the risks seem to be subsiding, its own model has the repo coming down to a final level of 7.25% in the current cycle — so only one more cut.
Its discussions next time will no doubt be as heated as they probably were this time, and the data versus risk-perceptions dilemma could be just as difficult. On the data, consumer price inflation outcomes have been consistently better than expected in recent months, with inflation hovering just above the 3% bottom of the target range.
The Bank’s forecasts don’t see inflation breaching the 4.5% midpoint of the target range — which is the committee’s effective target — soon. And they are significantly improved since the previous meeting. Headline inflation is now expected to average 3.6% this year, down from 3.9% at the time of the January MPC meeting, rising to 4.5% next year, down from 4.6%.
The forecasts do now factor in the impact of the March 12 budget’s VAT increases, which are expected to add about 0.2 percentage points to the inflation rate over the next 12 months. But that’s more than offset by lower forecast fuel and electricity price increases. Sadly, economic growth is also forecast to be slightly lower over the next few years, which means less demand in the economy and less price pressure.
It’s worth noting, too, that the rand, a big driver of inflation, has strengthened as sentiment towards the US economy and the dollar have soured. The rand was trading at R18.23 to the dollar at the weekend, down from R18.69 at the start of March, and below the committee’s exchange rate assumption of R18.50.
Yet it’s the rand that is really the risk bogeyman that the cautious committee fears. Nor is it alone: other central banks are being equally cautious, with US and global interest rates now expected to be high for longer and nobody knowing quite how much damage Donald Trump will do to the world.
The committee’s statement speaks of being sensitive to the risks. The four who preferred a hold are evidently ultrasensitive to the risks, global and local. It’s hard in a way to blame them, given global uncertainties about tariffs and other policy craziness, as well as SA’s own vulnerabilities and uncertainties.
In one of the Bank’s scenarios, a weaker US economy and US dollar could be mildly good for the rand and inflation. In others, Agoa withdrawal and tariffs on SA, or a “sentiment shock” towards SA, could be very bad.
Though the committee’s statement doesn’t mention the budget, and Kganyago was careful as always not to comment on fiscal matters, his colleagues are surely worried about the potential for investor sentiment to SA to turn sour if the budget doesn’t pass or the government of national unity unravels. The more hawkish among them are also hoping the Treasury will accede to the Bank’s push to lower the inflation target itself — a prospect that would justify keeping interest rates higher than might otherwise be the case.
The danger as always is that the Bank keeps interest rates too tight for far too long, damaging economic growth further and prompting a downward spiral that itself could be bad for investor sentiment. The committee’s statement suggests it doesn’t believe monetary policy can improve SA’s economic prospects: only structural reforms can do that. But it is surely taking a risk.
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