The MPC will rightly want to tread warily

The monetary policy committee (MPC) sits down this week for its first meeting of 2024, which is set to be the year the cutting cycle begins. But when that turning point will be is the big question. How steeply the Reserve Bank will reduce interest rates through the cutting cycle is another.

As always, what the MPC says will be as important as what it does this week. It is widely expected to hold again. That would make it the fourth consecutive meeting to hold the benchmark repo rate at 8.25% but, if the decision proves unanimous, it will be only the second meeting to post a unanimous vote. Research by RMB Morgan Stanley shows that extended periods of unanimous MPC voting have often preceded a policy pivot. Four unanimous “hold” meetings preceded the MPC’s first rate hike in November 2021. That suggests we could be in for quite a wait until it starts cutting later in 2024.

Until recently the market was pricing in a first cut as early as March. Some economists think it will be July, while several are predicting only in August. There are good reasons the committee will want to tread warily. Reserve Bank governor Lesetja Kganyago has made it clear he is setting the bar high for a cut. Speaking on the sidelines of the World Economic Forum in Davos last week, he told Bloomberg that SA’s real rates were not particularly high and inflation had come down to within the target range. However, he emphasised: “If we are to make any policy adjustments, we would have to see that inflation has declined to our anchor, which is 4.5%.”

Kganyago’s MPC has made the 4.5% midpoint the effective inflation target since 2017, rather than the full 3%-6% of the target range, and the governor has signalled he would like to take the target even lower over time, to make SA more competitive with its major trading partners. Going into this meeting the headline inflation rate is below 6% but inflation expectations, which had been coming down, are showing signs of edging up over the top of the target again, which is bad for the inflation outlook. The latest Bureau for Economic Research expectations survey published in mid-December showed average headline consumer price index expectations for the fourth quarter increased to 5.7% for 2024 and 5.6% in 2025 (up from 5.5% and 5.3% in the third quarter).

That will be a worry. So too will the rand exchange rate, which had gained in late 2023 but has weakened in recent weeks to trade in the R19/$ range again. That’s weaker than at the time of the MPC’s November meeting. And the rand is going to be one of the key risks to inflation that the committee will be watching in 2024 as it figures out when to pivot.

Like everyone else in the world, the committee is watching the US Federal Reserve. The signals from the Fed’s leadership lately have been volatile at best. First it was higher for longer. Then in December Fed chair Jerome Powell started talking multiple interest rate cuts in 2024 — prompting a rally in global risk appetite that helped to drive up the rand and other emerging market currencies. Now it’s back to high for longer. A small open economy such as SA, which is very dependent on foreign capital, has to watch the Fed carefully because its decisions fundamentally shape global risk appetite and global capital flows — which in turn drive the rand exchange rate, which then passes through to inflation. Even if our inflation outlook is looking decent, the MPC is unlikely even to consider moving on rates before the Fed does.

It will also be wary of other possible risks to the rand that are SA-specific, particularly the forthcoming budget and election. SA’s deteriorating fiscal policy metrics are one of the big risks for monetary policy that the Bank has been flagging over the past year or more. The higher the public debt and the less sustainable, the more this will weigh on inflation directly and indirectly, through the country risk premium that investors attach to SA assets and the currency. As long as fiscal policy is too loose, monetary policy may have to remain tighter.

In election season, there’s not a great chance that the ANC government can deliver on the ambitious public spending cuts it’s relying on to stabilise the public debt. The election itself is also a direct risk to the rand and to inflation: any sort of outcome that spooks the market could hit the currency hard. The MPC would be right to wait until the election risk has come and gone before it considers a move.

THE RAND IS GOING TO BE ONE OF THE KEY RISKS TO INFLATION THAT THE MPC WILL BE WATCHING IN 2024