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Only time will tell if rate hike is steep enough

It was a slightly grumpy governor Lesetja Kganyago who presented the monetary policy committee statement on Thursday afternoon, and who could blame him? The meeting must have been a tough one. And the big news was not that the committee opted in the end to hike interest rates by 75 basis points, as widely expected. It was that two of the committee’s five members would have preferred a 100-basis-point hike.

That signals how concerned the Reserve Bank is about the outlook and the world in general, even if the latest inflation figures appear a little better than expected. With SA’s economy now expected to grow at just 1.9%, down from the Bank’s 2% forecast two months ago, such steep hikes must have been tough to contemplate, whether 100 or 75.

And they would not normally be easy to justify given that the Bank has not changed its inflation forecast for 2022, which is still at 6.5%, and has cut 2023’s forecast from 5.7% to 5.3%, with food and fuel price inflation expected to come down.

However, Kganyago has in recent years targeted the 4.5% midpoint of the 3%-6% inflation target range. The Bank’s forecast now does not see inflation coming down to within the range until well into 2023. It will not be back at the midpoint of the target range until late in 2024.

And the risks, the committee emphasised, are to the upside — in other words, these inflation forecasts are more likely to prove too optimistic than too pessimistic. “The risks to inflation identified over the past year have been realised,” said Kganyago.

The global environment is a big worry. The rand has weakened about 3% since the committee’s previous meeting, which is not that bad. But SA’s currency is vulnerable in a context in which the world’s leading central banks are implementing sharp interest rate hikes, tightening global financial conditions, and as the committee put it “raising the risk profiles of economies needing foreign capital”.

In essence, the concern is that if SA’s central bank is not seen to be raising rates fast enough in sync with global central banks, investors will punish its currency and that will push up inflation.

Added to that is the global oil price, which has moderated somewhat but which Russia’s war in Ukraine could drive up again. In addition to the global risks there are the prices of commodities, and their effect on the country’s balance of payments, as well as on its fiscal position.

But much of the committee’s list of risks focused on domestic factors. It watches inflation expectations carefully for signs that the price and wage setters in the economy are increasing their forecasts and calibrating their behaviour accordingly, demanding higher prices and wages and so spiralling inflation up further. Expectations had climbed significantly in the second quarter; less so in the third quarter, but they are above the 3%-6% target range and still pose a risk.

Then there are electricity prices, which could well derail inflation forecasts even if Eskom does not get the 32% tariff increase it is asking for. And there are rising wage pressures, which themselves are driven by cost-of-living increases. The committee, appropriately, is trying to arrest a potential spiral and ensure inflation does get back to 4.5% in 2024.

At 6.25%, the benchmark repo interest rate is now back at pre-Covid-19 levels even though the economy and employment are not. But it is still negative in real inflation-adjusted terms, so the Bank is providing support to the economy even if it may not look that way. By hiking steeply now, the Bank is hoping to prevent even steeper hikes in the future that might hurt growth even more. Whether it has hiked steeply enough will become clear in coming months.

The priority, as Kganyago and his monetary policy committee colleagues have emphasised, is to put the lid on the cost-of-living increases that are hurting the poor hardest and if not contained will ultimately hurt growth.

IF SA IS NOT SEEN TO RAISE FAST ENOUGH IN SYNC WITH CENTRAL BANKS, INVESTORS WILL PUNISH IT

OPINION

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2022-09-23T07:00:00.0000000Z

2022-09-23T07:00:00.0000000Z

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