MPC on recession, growth tightrope
AT its first meeting of 2016, the monetary policy committee decided to hike rates 50 basis points to 6.75%.
The decision was not unanimous. Two members preferred a 25-basis points increase and one thought rates should be kept on hold.
Why did the MPC raise rates when we are in a slow growth environment?
The Reserve Bank’s inflation forecast shows a marked deterioration, with inflation expected to average 6.8% in 2016 and 7% in 2017 , after averaging 4.6% in 2015. Inflation is expected to breach the upper limits of the target band for most of 2016, peaking at 7.8% in the last quarter and first quarter of 2017.
The bank’s inflation forecasts are based on its assumptions of “a more depreciated real exchange rate and higher expected food price inflation”. Most members of the MPC felt it necessary to increase interest rates because of the deterioration in the inflation outlook.
MPC member Rashad Cassim noted that “responding to demand-side inflation is a real luxury these days”. In the past inflation was driven by an increase in demand, mainly consumer demand for goods and services, and inflation targeting deals more effectively with demand-side shocks.
What we have currently are exogenous supply shocks: rising food prices, which are a result of the drought and the weak currency, as well as energy and wage inflation. Pass-through from currency weakness to inflation has been relatively muted. However, a change in pass-through dynamics remains a risk to the inflation outlook.
Pass-through is already evident in the petrol price, with the current underrecovery suggesting an increase of about 7c a litre in February. And let’s not forget that in some parts of the world Brent crude oil, at just above $30 per barrel, is cheaper than bottled water.
The challenge facing the MPC is determining the extent to which exogenous supply shocks will affect inflation and inflation expectations and to ensure that these supply shocks do not feed into second- round effects.
The MPC is treading a tightrope as it tries to contain inflation without driving the economy into a recession. According to its own forecasts, growth is estimated to average 0.9% in 2016, from an expected 1.3% in 2015. Indeed South Africa is at risk of going into a recession.
The core mandate of the Reserve Bank is inflation targeting and as the MPC has constantly reminded us, growth constraints are of a structural nature and cannot be solved solely by monetary policy. Growth is determined by a range of real variables such as quantity and productivity of labour, infrastructure, capital in the economy, and the efficiency of the government and the judicial system. However, in
Responding to demand-side inflation is a real luxury these days
the medium term, monetary policy can provide a stable environment conducive to long-term growth.
We are in a low-growth environment and at this rate, it’s hard to see GDP growth of above 3% in the next three years. The Reserve Bank has played its part and even the rand responded positively by strengthening somewhat after the 50-basis points hike.
It’s now up to the president, who will be delivering his state of the nation address on February 11, and the Treasury to ensure that there are no fiscal slippages. It is also up to the Department of Trade and Industry, the Department of Small Business, the Planning Commission, the trade unions and the citizens of this country to ensure that we do not sink into recession.