Beware the Ides of March
Of all the SA victims of Covid-19, one of the least mourned is surely inflation.
Since February 2020 the Consumer Price Index (CPI) has fallen to historical lows of 3.2% and the South African Reserve Bank rate is also at a record low of 3.5%.
Can we therefore move on from the belief that SA has an inflation problem? Has the pandemic truly shifted the way money, interest rates and prices move in the economy?
In the US, the process of normalisation does seem to be under way. Although the Federal Reserve continues to be more concerned about the downside risk of deflation than inflation, the market is saying something else.
While the economy is still clearly battling, bond markets would tell a different story. In the US, Japan, China, Australia, Europe and the UK, 10-year bond yields are now at their highest levels in nearly a year.
If not throwing fuel on the fire then maybe chucking on a few extra bits of Charka Firelighters when the Brikettes already seem to have caught is Joe Biden’s much-mooted stimulus package. While it will not be as extensive as he wants, the effect will still be profound: more money to spend in the pockets of more American consumers.
Equity markets have already reacted over the first two months of the year with their customary jitters from a softening bond market. Higher bond yields will tend to lure investors away from an overheated equity market and back into 10-year treasuries.
Despite a more volatile equity market, what the market is saying is that in developed markets we may be witnessing the beginning of an economic recovery.
What of the situation in SA? First, rising rates and flagging equity markets should weaken emerging market currencies, including the rand, as international investors can access yields closer to home. A weakening rand will always put pressure on inflation, as SA is a massive importer of food, commodities and manufactured products. Second, the effect of a nascent recovery on the oil price has already been profound. Brent crude has rallied in the past two months to $65, its highest level in almost 18 months.
Finally, SA’s credit metrics and attractiveness for investors have not improved. Debt is still too high, budget deficits perilous, unemployment stratospheric and the long-term path to macroeconomic stability is looking more uncertain than ever.
Debt is still too high, budget deficits perilous, unemployment stratospheric and the long-term path to macroeconomic stability is looking more uncertain than ever
Fixed-income strategists at Nedbank therefore forecast that if the rand moves back to R16.50 or R17 to the greenback, and oil remains at between $50 and $70, then inflation could easily push up to 4.5% to 5%.
All of this puts more pressure on the Reserve Bank. Inflation from a weaker currency, higher commodity prices and a selloff in bonds is bad for the economy, as it will hurt consumers and business owners at exactly the moment they are most vulnerable.
This would be cost-push, as opposed to demand-pull, inflation. This would not be the consequence of an economic recovery but higher input prices.
If, therefore, this period of low interest rates and inflation in SA is seemingly coming to an end, how will Lesetja Kganyago at the Reserve Bank react? Will he prioritise the economic recovery and keep rates low, or react to rising inflation and a weakening rand by starting to hike rates? Either way, despite having had an arduous past few years, his job does not look set to get any easier.