MPHO MOLOPYANE: A US sneeze doesn’t have to result in a cold for SA

At the March Federal Open Market Committee (FOMC) meeting the US Federal Reserve lifted its policy rate by 25 basis points and indicated that it would continue hiking its policy rate in increments of 25 basis points at each of the remaining six meetings for the year.

However, at the May FOMC meeting the Fed raised its policy rate by 50 bps and signalled that further such increases were likely at the next two meetings — with the change in the pace of accommodation removal being in response to surging inflationary pressures.

Market participants have for some time been of the view that the Fed is behind the curve in terms of hiking, and as a result the FOMC will need to hike aggressively to stem inflationary pressures. Unfortunately, these expectations have filtered through into the SA rate market, with the forward rate agreements (FRA) market pricing in an additional 200 basis points of  hikes by year-end. This despite the different macro-economic fundamentals of SA and the US.

As an example, US headline CPI inflation surged to 8.5% in March, while core inflation increased to 5.3%, representing a deviation of 6.5 points and 3.3 points from the Fed’s 2% target. The Fed-targeted inflation (PCE) ticked up to 6.6% in March and core PCE rose to 5.2%. While this represents a smaller deviation of 4.6% and 3.2% from the Fed’s target, it nonetheless shows that inflationary pressures in the US have intensified. In contrast, SA’s headline CPI inflation reached 5.9% in March, which was 1.4 points from the Reserve Bank’s midpoint target.

Meanwhile, core CPI inflation for March was at 2.9% — 1.6 points below the Bank’s 4.5% midpoint of the target band. This highlights that headline CPI in SA has been pushed above the Bank’s target by supply-side factors (fuel, energy, as well as food and non-alcoholic beverages), while demand-push inflation is evident in the US in services components such as shelter costs (rental inflation).

Other data shows the US economy is now 4.1% bigger than pre-Covid, while the unemployment rate is at 3.6% — just 0.1 of a point below the pre-Covid rate. In contrast, the SA economy is still 1.8% below pre-pandemic levels and down 1.9-million jobs down relative to pre-Covid. Those macro-economic fundamentals suggest SA doesn’t have the same inflation problems the US faces, which supports the Reserve Bank continuing to hike at a gradual pace.

However, the Bank is going to have to contend with a faster pace of accommodation removal in advanced economies, which has led to a risk-off environment and worsened rand weakness. The monetary policy committee (MPC) is likely to cite capital outflow concerns and risks of higher import inflation stemming from currency weakness.

Furthermore, while SA doesn’t have the same inflation problems as the US, analysts have revised their forecasts higher as headline CPI inflation continues to edge closer to the upper end of the Bank’s 3%-6% target band — driven mainly by fuel and food inflation as the war in Ukraine has worsened global supply shortages and pushed up prices of several commodities.

The May Reuters survey shows that analysts now expect headline CPI inflation to average 5.9% this year and moderate to 4.7% and 4.5% in 2023 and 2024 respectively. This is up from 5.5%, 4.4% and 4.4% in the March survey.

Two of the five MPC members already expressed a preference to lift the repo rate by 50 bps points at the March meeting, and the hawkish tilt by policymakers in advanced economies, coupled with analysts’ upwardly revised inflation expectations might be enough to sway one additional MPC member.

On the back of this, it is likely the Bank will hike the repo rate by 50 bps at the conclusion of the May meeting on Thursday. Thereafter the MPC will probably move in increments of 25 bps as the negative impact of lockdown restrictions in China, the KwaZulu-Natal floods and load-shedding become apparent in the second quarter 2022 data.

Given the aggressive hiking cycles in advanced economies, the Reserve Bank will have to hike at each of the remaining meetings in 2022, taking the repo rate to 5.5% by year-end. That will still be lower than the 6.25% priced by the FRA market, but a further 75 basis points of hikes are likely in 2023, taking the terminal repo rate to 6.25%, still lower than the 7.5% priced by the FRA market.

• Molopyane is an economist at Rand Merchant Bank.