Bank walks a fine line on interest rates
IN line with expectations, the Reserve Bank this week opted to maintain the repo rate at 7%. The decision came despite an upward revision to its inflation forecast.
The bank now expects the inflation rate to average 6.2% relative to the 5.8% pencilled in at the end of last year. Furthermore, inflation is expected to remain above the target band for most of this year, only returning within the bank’s target in the fourth quarter.
Granted, the factors driving inflation are transient, and the downward adjustments in average inflation expectations for the second consecutive quarter underlined this. However, the bank’s willingness to tolerate an extended breach of the target band suggests it is concerned about weak economic growth.
Elevated food prices seemed to have been the main instigator behind the Reserve Bank’s inflation revision. The bank is now more bearish on food prices (particularly meat) than it was in its November sitting.
Developments in the food market suggest this cautious approach may be warranted. While agricultural prices have steadily declined, thanks to improved rainfall and lower global prices, the price drops have not been broad-based.
Meat prices were supported by drought-induced culling over the past year. However, rebuilding of stock, combined with reduced poultry supply due to avian flu in Europe, suggests prices will remain sticky for longer.
Given that meat accounts for around 30% of the food-inflation basket, notable increases will offset improvements in other categories, particularly grains and vegetables. As such, the bank’s assessment of a moderate improvement in food prices this year is justified.
Short-term upside risks to the inflation outlook have been mitigated by a relatively stable rand/dollar exchange rate.
However, a faster acceleration in inflation in the US that forces the Fed to hike interest rates more aggressively remains a significant risk. This will weigh on the rand, domestic inflation and, ultimately, growth. Also of concern is rising anti-globalisation sentiment, which, if manifested in policy action, could usher in a period of global stagflation.
Locally, political developments pose the biggest risk to the rand outlook, especially if policymakers implement ill-advised policies with negative repercussions for financial markets and the broader economy.
New information expected in the weeks ahead could necessitate a shift in tone when the monetary policy committee meets again. By that time it will have the rebased and reweighted January and February inflation survey. The bank may also have factored in new information regarding sugar taxes and the fuel levy. Possible double-digit increases in medical-aid costs would have also been considered.
A rate cut in 2017 is highly unlikely
Given the uncertainty regarding the inflation outlook, the bank may have missed an opportune time to hike the repo rate; the emergence of second-round effects that undermine the long-term inflation outlook would sway its hand. However, in the absence of this the bank may opt to keep rates steady for longer.
With the elevated inflation profile forecast by the bank, a rate cut in 2017 is highly unlikely. In our view, headline inflation would have to fall below 5% for a number of months with very limited upside risk to the exchange rate. In conjunction with this, the Fed hiking cycle would have to be gradual with very little policy fallout from the new Trump administration.
Nxedlana is FNB chief economist