WHICH IS WORSE: INFLATION OR NO GROWTH?

wo monetary policy committee meetings will take place in July that could have significant implications for the rand, inflation and interest rates.

The first will be that of the South African Reserve Bank (the Bank) from July 19-21, followed a week later by the Federal Open Market Committee (FOMC) in the US, from July 26-27.

In May, faced with the continuing dilemma of upside risks to the inflation forecast combined with a worsening growth outlook, SA’s monetary policy committee (MPC) paused in its rate hiking cycle, holding the repo rate at 7%.

Despite some improvement in consumer inflation since February, the MPC considers this respite temporary. It remains concerned about the inflation outlook.

Inflation is expected to peak at 7.3% in the fourth quarter of this year and remain above the upper limit of SA’s 3%-6% inflation target until the third quarter of 2017. This is bad enough, but the balance of risks is tilted towards an even worse outcome, the MPC fears.

Chief among these risks is the rand exchange rate, which, the MPC says, “remains highly sensitive to domestic political developments and risks of an earlier-than-expected tightening in US monetary policy”.

At the same time, the MPC regards the domestic economic outlook as “weak”. Annualised growth in the Bank’s leading indicator of economic activity has contracted for 29 consecutive months, suggesting that growth could slow further.

At the May meeting the risks to growth were judged more worrisome than those to inflation and the six committee members voted five to one in favour of not hiking.

There are several compelling arguments against the Bank hiking at the July meeting too, not least because the MPC showed so little appetite for a May hike. The fact that only one committee member was in favour of hiking at the last meeting suggests that the bar is set quite high against further rate hikes.

Since May, SA’s growth trajectory has continued to worsen and the economy now stands on the cusp of a recession.

There is no central bank in the world that wants to hike interest rates into a recession, least of all in SA, where more than 26% of the working-age population is already unemployed and food inflation is rising towards double digits.

According to Stats SA figures published last month, SA’s GDP contracted at an annualised 1.2% in the first quarter, down from a positive 0.4% in the fourth quarter of 2015.

In May, the Bank revised down its GDP outlook yet again from 0.8% to 0.6% for 2016, but this was on the assumption that first-quarter growth would be positive, if only barely. The fact that growth has turned out to be decidedly negative suggests that the Bank will have to revise down its growth forecast again at the July meeting.

Many economists, too, expect the first quarter to prove to be the low point for 2016 and for the economy to recover slowly from here on out. Even so, several are revising their growth forecasts lower since the disastrous first-quarter number and believe it is becoming increasingly likely that the Bank will opt for only one more rate hike this year, if it hikes at all.

Several economists are revising their growth forecasts lower and believe it is likely the Bank will opt for only one more rate hike this year, if it hikes at all