Grinch is set to grab rate cuts too

In the IMF’s annual World Economic Outlook update published this week, global growth was revised higher for 2023. The fund’s economists are encouraged by three factors. China reopened after three years of Covid-19 lockdowns, which should bolster global demand and ease inflationary supply chain blockages. Labour markets and household demand in developed economies have been more resilient. Global inflation is slowing, which should make central banks less hawkish.

The US Federal Reserve is expected to be cutting rates by the end of 2023. The dollar has depreciated, and financial conditions have eased. The IMF forecasts that 2023 will prove the low point for activity growth and global growth will rebound from 2024 onwards.

The easing in financial conditions implied by higher global growth expectations and a potential monetary policy pivot would typically lead to the rand strengthening, underpinning improvement in inflation and thus the monetary policy outlook. The premise here would be that SA’s balance of payments would benefit from a combination of an improvement in exports via better terms of trade, and positive capital flows as cash comes in chasing better growth and higher returns.

Because of load-shedding the rand is not benefiting fully from the more constructive global environment. In contrast to the strengthening trend in the currencies of other large emerging markets, it weakened relative to the dollar so far this year. The rand has’ s decoupling from other currencies will probably be reflected in tighter monetary policy in the domestic market relative to comparable countries.

The Reserve Bank published its economic expectations after its monetary policy committee met last week, revising its domestic growth forecast for the year sharply lower to a stall speed of 0.3% from the crawl pace of 1.1% it expected in November. The downward revision mostly reflects the expected drag on growth from a misfiring Eskom.

Economists expect that growth will have contracted in the last quarter of 2022, and if sustained, the intensity of loadshedding in the first quarter of 2023 will probably result in another low growth print or quarterly contraction. On the technical definition of two quarters of negative growth, it is possible that SA is now in recession.

The inflation forecast was revised higher for the second half of 2023 into 2024 as a result of energy regulator Nersa’s decision to grant Eskom an 18.65% tariff increase this year, compared with the 9% increase the Bank had previously assumed. By depressing growth even as it raises inflation Eskom is a stagflationary nightmare for policymakers.

Even as they lowered growth expectations, Bank economists forecast that the output gap — the difference between the level of output and its sustainable level — will not change. Under normal circumstances lower growth would imply a wider negative output gap and justify easier monetary policy settings. That the Bank lowered growth expectations without an adjustment in the output gap implies that lower growth is not expected to be disinflationary. Monetary policy will therefore not adjust to compensate for the lower growth.

The debate about monetary policy in the domestic economy will probably be heated as we go further into the year. When other central banks ease in response to supportive global conditions, many will ask why Bank governor Lesetja Kganyago and his monetary policy committee do not cut as aggressively as others, especially if the Bank itself expects growth to be moribund.

The answer will be Eskom, the Grinch that stole Christmas and will also steal rate cuts this year.

There will be calls for the Bank to do more to ease conditions for households and businesses. The commentariat will say keeping rates high in a zero-growth environment makes no sense. However, energy constraints make any sort of growth difficult to sustain in this economy. Eskom has this economy in a chokehold, and this will continue to bleed into every area of policy in suboptimal ways.

The need to deal with the energy shortage has never been more urgent.