Greener pastures ahead, but many risks remain
The announcement by the Reserve Bank after its recent monetary policy committee (MPC) meeting that interest rates would be left unchanged came as welcome relief for consumers. Adjustments to interest rates over the past two years have been hard hitting and have had a material negative effect on consumers.
SA has experienced depressed demand, and elevated rates continue to reverberate through the system. Yet the domestic picture is in stark contrast to that of the US, where most consumer-centric economic indicators remain robust and GDP growth was 3.3% in the most recent quarter, blowing out the most optimistic of projections.
But there may be greener pastures ahead for SA if the Reserve Bank’s inflation forecasts are anything to go by. These imply that it should have sufficient room to manoeuvre and cut rates in the second half of the year. This is good news for consumers. It is safe to say that the purse strings are about as tight as they will get in this cycle. Debt financing costs should taper off in the near future, coupled with lower inflation.
Broadly speaking, inflation appears to have been contained. But while there is scope for optimism regarding interest rate and inflation expectations, it is important to remember that inflationary pressures were largely driven by exogenous factors, and to keep some of those risks in mind.
Geopolitical risks have been increasing globally over the past few months. The risk of spillover effects of escalating tensions are material, especially regarding global trade. Disruption to the Suez Canal, one of the most important global trade routes that is considered a proxy for global supply chain pressures, presents a genuine threat to the continued containment of inflation.
A concern recognised by Southern Africa Freight News recently is preliminary evidence suggesting that many shipping companies are travelling past the bottom of Africa from Asia en route to the UK. The effect of this is estimated to increase shipping distances from 12,000km to nearly 20,000km.
KEEP AWAKE
We should equally be nervous about escalating issues in the Strait of Hormuz. The strait plays a critical role in global oil trade and is responsible for about 20% of global oil consumption.
These issues will certainly keep central bankers awake at night. Geopolitics will play a critical role in global inflationary dynamics, much the same as it did after the escalation of the conflict in Eastern Europe.
The Reserve Bank tends to err on the side of conservatism, and perhaps continuing to advocate for incremental improvements in the structural elements of SA’s economy is the right approach.
SA-specific risks must be dealt with so that the currency dynamic can improve. The effects of high or low interest rates are similar to how a weak or strong currency affects inflation. An incrementally stronger currency can result in reduced imported inflation, which in turn improves the inflation outlook.
There has lately been some evidence of improvements at Eskom, with lower levels of load-shedding in January. The situation at Transnet remains fluid, but to some extent issues at ports experienced at the tail-end of 2023 seem to have dissipated somewhat. However, the permanence of interventions at state-owned enterprises (SOEs) will influence the structural trajectory of the rand.
The Bank has room to cut rates, and so does the US Federal Reserve. It was unlikely the US Fed was going to adjust interest rates last week, but the Fed’s preferred gauge of inflation core private consumption expenditure inflation is rapidly approaching the 2% central bank target (last print 2.9%).
The minutes from the US federal open market committee meeting that took place last week will be released in the coming weeks and will provide a useful guide for the US interest rate trajectory.
One concern is the continued strength of the US economy, which may induce greater caution by the Fed, but we should be more concerned about the lag effects of high interest rates and the broader implications for the US economy.
It seems inconceivable that a hiking cycle of this nature can have an immaterial or negligible impact on economic activity in the US. The excess savings still in the US economy will eventually deplete, leading to an abrupt unwinding of US economic performance if interest rates remain high.
One way for SA to defend itself against weaker growth among its trading partners is to ensure that it operates at maximum capacity, by implementing programmes that suit its structural capabilities. Just last week, the IMF revised SA’s GDP growth projections down, citing logistics constraints, reminding us just how important SOEs are for economic growth.