IN­FLA­TION, LOW GROWTH: SA NEEDS RE­SHAP­ING

Financial Mail - Investors Monthly - - Opening Bell -

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

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