EDITORIAL: Rising cost of living requires staying the course on rate hikes

Global and local dilemmas make for a challenging background to the Reserve Bank’s monetary policy committee meeting this week. 

On the global front, banking sector turmoil after the failures of two smaller US banks and one large Swiss bank has created a new layer of uncertainty about the outlook for interest rates. The rapid rise in interest rates exposed weak bank balance sheets and business models, so was one of the key factors that sparked the banking crisis. That prompted concern that central banks in the US and Europe could make the crisis worse if they keep raising rates. But inflation is as much of a concern as before in those markets. That is now even more so in the US because the government’s decision to bail out the banking sector will pump huge amounts of liquidity into the economy, undermining the US Federal Reserve’s efforts to tighten financial conditions to slow the economy and fight inflation. 

Against this, the Fed suggested at its meeting last week that the crisis could itself tighten financial conditions because it would make bankers and other lenders much more risk averse. The Fed proceeded with a 25 basis point hike at last week’s meeting — but indications were that it would have opted for 50 basis points had it not been for the banking crisis.  

How the crisis and the bailouts will ultimately play out for interest rates in advanced markets will take a while to become clear. Global inflation is by no means out of the picture, and for SA that probably means the pressure on local inflation via imports and the rand will remain.  

Services prices

For now, the Fed’s less hawkish stance last week has given a slight boost to the rand exchange rate. But at about R18 to the dollar it’s still well above its January level of about R17. The exchange rate is one big risk to inflation that SA’s monetary policy committee will be worrying about this week. It’s well aware that if it falls too far behind the pace of interest rate hikes in advanced markets, it risks the rand getting hammered further. It will be aware too that in volatile global markets, with volatile global geopolitics, there’s always the risk of further external shocks to the rand and to inflation. 

But the committee will also be closely watching domestic inflation pressures. Latest data shows that SA’s consumer price inflation rate edged up to 7% in February after falling for six successive months. This reflects specific one-off factors, such as an increase in health insurance costs, which may not be repeated. However, the committee will be concerned about the core inflation rate being up more than expected, driven particularly by increases in prices of services.

It might be even more concerned about the trend in inflation expectations, which the latest Bureau for Economic Research survey shows rose to an average 6.3% in the first quarter of 2023, from 6.1% in the fourth quarter of 2022. Even though inflation is expected to decrease in coming months, it’s still far from the 4.5% that the Bank targets. Rising expectations suggest price and wage setters in the economy could keep it there — unless the Bank stays the course on interest rate hikes. 

The committee is widely expected to raise rates this week by 25 basis points. As always, what it says will be as important as what it does. With the cost of living rising rapidly, especially for poorer South Africans, staying the course on interest rate hikes has to be the right thing to do.

It is most unfortunate that it has to do so in an economy that is so weak. At its most recent meeting, the Bank forecast growth of just 0.3% this year; the IMF’s new forecast is even weaker at 0.1%.

What’s more tragic though is that even at this level of stagnation, the Bank estimates the economy is still growing above its potential or trend growth rate, so the inflationary pressure is still there. SA’s potential growth rate is basically zero, on the Bank’s estimates. That reflects the constraints on growth from high levels of load-shedding, as well as the dysfunction in transport and other public services.

There’s not a lot the Bank can do about that. But there’s little doubt that the structural reforms SA so urgently needs to boost growth could also address some of the Bank’s interest-rate dilemmas.