INFLATION, LOW GROWTH: SA NEEDS RESHAPING

he key economic event in May will be the May 17-19 meeting of the monetary policy committee (MPC).

Following the MPC’s 50bp hike in January and further 25bp hike in March, which took the repo rate to 7%, financial markets are pricing in a chance of around 80% that the committee will hike again in May.

The Reserve Bank’s biannual monetary policy review (MPR) provides deeper insight into the MPC’s thinking about the outlook for inflation and interest rates. Released last month, the document was decidedly bearish on inflation, suggesting the risk of another rate hike in May is high.

With inflation at its highest level in nearly seven years (at 7% in February), and with the target breach expected to last until late 2017, the Bank is deeply concerned about the inflation trajectory. It sees the risks to the inflation outlook as being on the upside, shared mainly between rising food prices and the vulnerable rand exchange rate.

At the same time, it sees the risks to SA’s growth outlook as being to the downside, noting that the economy has decelerated markedly since 2011.

GDP growth was just 1.3% in 2015 and the consensus is that it will fall to less than 1% this year, the slowest pace of expansion since the 2008 global financial crisis and, before that, the emerging-market crisis of 1998.

“In the recent past, disappointing growth outcomes have been traceable to specific shocks, including strikes, electricity shortages and drought. But the outlook now indicates more diffuse sources of weakness,” notes the MPR.

The Bank expects growth to be low over the next two years.

T“The economy faces the most intense stagflationary bind since 2010,” summarises Citi Bank economist Gina Schoeman. Stagflation exists when high inflation and low growth occur simultaneously.

Schoeman argues that “unduly high inflation will hurt the economy more than a gradual interest rate hiking cycle”.

The Bank makes much the same point in the MPR, stating that over the longer run “SA’s growth interests are best served by keeping inflation within the target range, not by looking to exploit a temporary trade-off between growth and inflation”.

Tolerating additional inflation in the short run could also require larger interest rate adjustments later, with proportionally greater costs for the economy, the MPR adds. Higher inflation would also “damage competitiveness, erode living standards and weaken confidence”.

The MPR repeats the Bank’s mantra that alongside sharp price declines for most of SA’s commodity exports and slower world growth, “the major constraints on domestic growth are structural” and that “these problems do not respond directly to monetary policy interventions”.

This does not sound like a Bank that is ready to stop hiking rates but rather one that is building a case to continue its hiking cycle despite the country’s poor growth outlook.

Rand Merchant Bank currency strategist John Cairns describes the MPR as downright hawkish, saying “most disinflationary trends were either explained away or were forecast to turn quite soon”. And while SA’s growth prospects were said to be weak, “the Bank does not see itself as the correct entity to address this structural slowdown”.

The Bank’s worries over the inflation outlook suggest to Cairns that the risk of another rate hike is high. However, he thinks the likely deterioration in local growth data over the

GDP growth was just 1.3% in 2015 and the consensus is that it will fall to less than 1% this year