MON­E­TARY POL­ICY: Late in­ter­est rate hike would still make sense

Finweek English Edition - - COLUMN - GRETA STEYN

The ques­tion arises whether it makes sense to raise in­ter­est rates when in­fla­tion is about to peak and eco­nomic

ac­tiv­ity is al­ready slow­ing


THE RE­SERVE BANK should al­ready have raised in­ter­est rates if it plans to do so, as mon­e­tary pol­icy is sup­posed to be for­ward-look­ing. It won’t make sense to raise in­ter­est rates just as in­fla­tion is about to peak and the econ­omy is slow­ing down. That’s the word from San­lam group econ­o­mist Jac Laub­scher, al­though he puts the ar­gu­ment more sub­tly than I have sum­marised it.

Laub­scher writes: “Time is march­ing on and this ex­pec­ta­tion [that the Bank will in­crease the repo rate later this year] is be­com­ing in­creas­ingly doubt­ful. The ques­tion is whether an in­crease in the repo rate in the near fu­ture will still make sense given the nor­mal lag in the im­pact of mon­e­tary pol­icy and the ex­pected course of the econ­omy.”

In other words, the time it takes for in­ter­est rates to take ef­fect and the ex­pec­ta­tion of a slow­down in SA’s econ­omy would make an in­ter­est rate in­crease un­nec­es­sary by the time in­fla­tion is at or near its peak – in first quar­ter 2012.

Laub­scher ar­gues the shape of the global econ­omy doesn’t au­gur well for our lo­cal econ­omy. At an in­ter­na­tional level, eco­nomic ac­tiv­ity has slowed markedly over the past quar­ter, es­pe­cially in the man­u­fac­tur­ing sec­tor.

Al­though the de­cline is likely to be tem­po­rary and eco­nomic con­di­tions will im­prove again later this year, growth next year is nev­er­the­less ex­pected to be hardly bet­ter than this year and fore­casts are be­ing ad­justed down­ward. It there­fore seems as if the low level of core in­fla­tion in de­vel­oped coun­tries will be main­tained and the up­ward pres­sure on head­line in­fla­tion over re­cent months as a re­sult of ris­ing com­mod­ity prices is prob­a­bly close to a high.

Laub­scher writes the Euro­pean debt cri­sis es­sen­tially re­mains un­re­solved, as the po­lit­i­cal will to end it once and for all is lack­ing. Euro­pean pol­i­cy­mak­ers are ap­par­ently try­ing to gain time in or­der to en­able the sys­tem to ab­sorb the even­tual losses with­out dis­rupt­ing the mar­kets, among oth­ers by giv­ing banks time to strengthen their cap­i­tal po­si­tions. The un­cer­tainty about the Euro­pean debt cri­sis will con­tinue for some time to come.

With re­gard to SA’s econ­omy, the out­look for the eco­nomic cy­cle is not very dif­fer­ent. Eco­nomic growth is ex­pected to slow af­ter a bet­ter than ex­pected per­for­mance in first quar­ter 2011 and there’s a real chance eco­nomic growth next year will be lower than in 2011.

In­fla­tion is likely to reach a high in the next nine months. That could even be lower than 6%, de­pend­ing on the rand and oil. The turn­ing point will be within the nor­mal lag pe­riod for mon­e­tary pol­icy to take ef­fect. Put dif­fer­ently, an in­crease in the repo rate in sec­ond half 2011 will make no dif­fer­ence to the course of in­fla­tion un­til af­ter it has reached its high.

For Laub­scher the ques­tion arises whether it makes sense to raise in­ter­est rates when in­fla­tion is about to peak and eco­nomic ac­tiv­ity is al­ready slow­ing down. How­ever, mon­e­tary pol­icy has be­come re­ac­tive since the in­tro­duc­tion of in­fla­tion tar­get­ing.

Turn­ing points in the in­ter­est rate cy­cle fol­low turn­ing points in the in­fla­tion cy­cle in­stead of pre­ced­ing them, which is con­trary to the idea that mon­e­tary pol­icy is for­ward look­ing in na­ture. Laub­scher as­cribes that to the politi­ci­sa­tion of in­ter­est rate de­ci­sions and con­cludes with the ques­tion: “A late re­ac­tion by the (Bank’s) Mon­e­tary Pol­icy Com­mit­tee can­not be ex­cluded, but will it make sense?”

Laub­scher’s ar­gu­ment is con­vinc­ing, but I be­lieve the Re­serve Bank has no choice but to raise in­ter­est rates if in­fla­tion nears or breaches the tar­get – even if cost-push fac­tors, such as oil and food, are the main rea­son for that, rather than de­mand. The Bank needs to send a mes­sage to the pub­lic that it will re­act to high in­fla­tion. It needs to do that to man­age ex­pec­ta­tions. The an­swer to Laub­scher’s ques­tion is: Yes, it will make sense to raise in­ter­est rates later on, as ex­pec­ta­tions feed into the in­fla­tion­ary process.


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