INTEREST RATES Let repo rate be guided by the economy

The volume of retail sales in SA has gained welcome momentum off a very weak base. By March real sales were up 4.8% compared to a year before.

This growth in spending was stimulated by a sharp decline in retail inflation from early 2017. Retail inflation was 7.4% in March 2016 and declined steadily to 1.6% in March 2018. Retail sales actually contracted by 1.7% in December 2016. A year later growth was over 5% per annum. The real sales cycle was at a trough when the retail price cycle was at its peak in the fourth quarter of 2016.

There would be little reason to regard the rate of retail sales growth as representing a peak in the cycle — were it not for a concern that retail price inflation may have reached a cyclical trough. The declining trend in retail and headline inflation since mid-2016 had much to do with the stronger rand.

Another force acting particularly on food price inflation was the end of the drought of 2016. Inflation peaked after the dollar-rand exchange rate reached its weakest point in late 2015. And headline and retail inflation receded after the rand strengthened on a year-on-year basis. Thus the future of inflation in SA will depend, as it always does, on the exchange rate.

The key to the exchange value of the rand in the months to come (and so for the outlook for inflation) will be the behaviour of the dollar. Dollar strength versus the euro is likely to mean as much or more weakness in emerging market currencies – including the rand, as has been the case since mid-April. The US dollar has gained about the same 7% versus the euro and the emerging market currency index and the rand since then.

Most of what happens to the dollar-rand in coming months will reflect the force of the US dollar. The “Ramaphosa effect”, which gave the rand extra strength compared with other emerging market currencies earlier in 2018, is probably over for now.

Nor are SA’s interest rates — any more than interest rates in Argentina or Turkey — likely to influence exchange rates when capital flows to the US dominate exchange rate movements as they have been doing.

The dollar strengthens when the US economy is expected to grow faster than other developed economies, and vice versa. Relatively faster growth in the US means US interest rates are likely to rise relative to interest rates in Europe and Japan, so attracting flows into the dollar. Hoped-for synchronised global growth would restrain dollar strength, protect the rand and improve the outlook for inflation and growth in SA.

The best monetary policy can do in SA in these circumstances (as in any economy buffeted by a strong US dollar) is to let interest rates take direction from the state of the economy — not from the outlook for inflation when it is dominated by forces beyond the influence of domestic interest rates and the domestic business cycle, as is the case.

The danger to the South African economy and others similarly affected by further dollar strength (not domestic excesses) would come from higher interest rates, pushed up in reaction to the essentially temporary impact of a stronger US dollar on domestic inflation.

It would be much better to ignore the dollar, to allow an unavoidably and unwelcome weaker exchange rate to act as a shock absorber and wait for a dollar shock to pass by, as it is likely to do. That is far preferable to depressing domestic spending by increasing interest rates.