Bank is alert to clear and present danger
Three days ago, it might have been a challenge for the Reserve Bank’s monetary policy committee to justify why it had no plans to start cutting interest rates some time soon.
The rand opened on Monday morning at its strongest level in almost two years — since well before Nenegate. Global and domestic factors suggested the rand’s strength could continue, which would be good for the inflation outlook.
Though the committee has not been expected to do anything to rates at its meeting this week, a good few economists and fund managers had started to look to at least one and possibly two rate cuts later in 2017, with more to come in 2018.
Then came the road show recall, which we have to assume is the start of the showdown that has to happen between President Jacob Zuma and friends, and Finance Minister Pravin Gordhan. The rand dropped 3%-4% and then pulled back some, but the somewhat muddled response of the market to the recall is nothing compared with what’s likely to happen if Gordhan is dismissed.
The clear and present danger to the rand will surely vindicate an ultra-cautious stance by the committee, which has indicated all along that the rand was the single biggest risk to the inflation outlook. But, arguably, the committee should not be rushing into rate cuts anyway.
One reason is that the inflation outlook is nowhere near where it should be, and if the committee were to cut rates as soon as inflation was headed below 6%, it could send all the wrong signals.
But another reason is the rand itself. Though the Bank is supposed to target inflation, not the exchange rate, its interest rate decisions affect the value of the rand and it very clearly does worry about that — a worry that’s relatively easy to justify, given the rand’s effect on inflation.
As always, what the committee says is as important as what it does, so it’s the nuances of its comments that have to be interpreted. “We may be near the end of the rate hiking cycle”, has been the mantra at the past three meetings or so, with slight but important shifts of tone, the latest one coming with a warning that it might have to reassess this view.
The real issue for the committee is where inflation will be in 12 to 18 months — and how low it has to go, for how long, to justify a rate cut. The inflation target range is 3%-6%, so ideally the committee would be trying to get inflation down to at least the midpoint of 4.5% and keep it there or below. SA hasn’t seen 4.5% too often in the past few years and the committee has often expressed concern that inflation, and inflation expectations, are stuck “uncomfortably” near the top of the target range. The 6% ceiling has come to be perceived as the target and businesses and trade unions behave accordingly when they set prices and wages.
The forecasts don’t show inflation coming down to an average of 4.5% in the next two years, so in theory, cuts shouldn’t be on the horizon at all. But given SA’s very weak growth, the committee must find a balance.
Economists such as Elna Moolman argue that if the 2018 forecast comes down to about 5%, that would justify two or three rate cuts over the next 12 months. Others, such as Barclays Capital’s Peter Worthington, say there is no sign of a sustainable fall in inflation and cuts can’t be justified any time soon.
Overlaying that is the more unofficial target: the rand. International investors tend to pile into emerging markets in search of the high yields they can’t get in low-rate developed markets. But their perceptions of the relative riskiness of emerging versus developed markets keep shifting, and capital flows have been volatile as risk-on episodes have been punctuated by risk-off ones.
With commodity prices strong, the shine wearing off US President Donald Trump and dovish comments out of the Federal Reserve, there have been unprecedented flows into emerging markets in recent weeks, driving their currencies to new highs.
The Institute of International Finance reports that the most inflows since September 2013 took place in the week ending March 22, including into SA. This was despite the recent Fed rate hike, which might have been expected to make emerging market yields less attractive, causing capital flight. This week Citi devoted a lengthy report to the question of “why EM seems happy to ignore the Fed tightening for now”.
SA had been riding the wave, helped by its December success in averting ratings downgrades and last week’s unexpectedly low deficit on the current account of the balance of payments. A low current account deficit makes SA that much less vulnerable to capital flight. But few expect it will be sustained. SA remains dependent on the kindness of strangers to finance its current account deficit; it is still vulnerable to flight by those very international investors that Gordhan went to meet before he was so rudely recalled.
A ratings downgrade still looms. The growth rate is still well below emerging market peers and the unemployment rate well above. Policy is uncertain and politics is fractious. At least SA can offer an independent and credible central bank and high-yielding assets. The wrong signals on monetary policy could derail even that.
SA IS STILL VULNERABLE TO FLIGHT BY THOSE VERY INVESTORS THAT GORDHAN WENT TO MEET BEFORE HE WAS SO RUDELY RECALLED