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The Reserve Bank in Pretoria. Picture: FINANCIAL MAIL
The Reserve Bank in Pretoria. Picture: FINANCIAL MAIL

As we write this, it has been about two months since Russia invaded Ukraine, and the war shows little sign of ending any time soon.

While hope for a peaceful resolution remains, it will not be easy to attain, and markets have now begun to reflect this. Aside from the tragic loss of life, what impact will the war have on the global economic outlook?

Further pressure is being levelled on the cost of living, especially given the surge in commodity prices. Energy prices have been a focus, but food security is also important and could have unforeseen consequences.

The Reserve Bank’s monetary policy committee (MPC) meeting in March took place against a backdrop of heightened uncertainty about the direction of the oil price, inflation, global growth, and the US Federal Reserve’s more aggressive front-loaded rate-hiking trajectory.

As expected, the Bank continued its gradual rate-hiking cycle — increasing the repo rate by 25 basis points to 4.25%.

However, the debate shifted from being between no hike or a 25-basis-point rate hike in January, to between a 25-basis-point hike or a 50-basis-point rate hike in March, indicating the MPC’s shift towards a more hawkish view. This can be attributed to several factors: the bank’s elevated 5% average core inflation forecast in 2023; its expectation that the output gap will close faster (in response to upward growth forecast revisions); and the sizeable lift in inflation expectations even ahead of the war-induced food and fuel price spikes. Thus, the cumulative 2022 hikes will, to a large extent, depend on the evolution of the war. The shorter the war, the quicker fuel and food price spikes should reverse (at least partly).

Based on the Bank’s revised forecast, its initial judgment is that a global stagflation shock, brought about by the war, will have a more pronounced impact on driving SA inflation vs curtailing real GDP growth. In the Q&A session, the Bank governor highlighted that, because of a “multiplicity” of external price shocks (pandemic-related supply chain bottlenecks, and a persistence in rising global food and energy prices), the risk of broader price pressures has risen.

Not surprisingly, in terms of magnitude, the Bank’s most significant upward revision was for an increase in 2022 headline consumer price inflation — revised up because of higher oil and food price assumptions, with headline inflation now expected to breach the upper end of the inflation target at an average of 6.2% in the second quarter of 2022, returning to about the midpoint of the target in 2023. Ultimately, the inflation trajectory will benefit from the favourable base effects these spikes are creating.

The Bank’s revised 2022 real GDP growth forecast was somewhat surprising. Despite lowering its global real GDP outlook to 3.7%, it raised SA’s growth forecast to 2% (from 1.7%). This is due to the better-than-expected SA real GDP growth in 2021 (that is, implying a slightly better starting point), an upward revision to growth in the first quarter of 2022 and the expected boost from much higher export commodity prices.

A sharp upward revision to the Bank’s 2022 nonoil commodity price forecast saw a major adjustment to the current account balance outlook. At a projected 3% of GDP, if it materialises, the sizeable surplus on the current account should continue to shield SA from volatile foreign capital flows amid accelerated global policy and long-term interest rate normalisation.

Our analysis of the Bank’s latest forecasts, MPC statement and Q&A session are that there is a high level of uncertainty attached to the medium-term forecast. The uncertain outlook and upside forecast risks imply that policy decisions will remain data-dependent, as reiterated in the latest MPC statement.

The MPC remains focused on inflation expectations and second-round effects embedded in core CPI. Unsurprisingly, the money market became more hawkish after the meeting, with the preference of nearly half the MPC members for a larger adjustment strengthening the market’s conviction that steeper rate hikes are coming.

While in this volatile global environment uncertainty is indeed the only certainty, the unpredictability of the war, in our view, supports gradual rate hikes against the current economic backdrop and forecasts. We doubt that a 50-basis-point hike will curb inflation or inflation expectations more than two 25-basis-point hikes, while it may weigh on a still-fragile growth recovery that could be curbed further depending on how the war unfolds.

Nonetheless, we acknowledge the risk of a front-loaded 50-basis-point rate hike in May should more concrete signs of second-round domestic price effects emerge.

Conversely, while SA’s growth momentum appears to have been robust in early 2022, we remain concerned that growth could potentially soften materially from the second quarter of 2022 as the combined effects of higher inflation and interest rates start to squeeze household income and non-commodity export volumes feel the drag of softer global growth.

Still, we expect the repo rate to rise to at least 6% over the next two years, though the unpredictability of the war makes it particularly hard to forecast the exact timing of each rate hike.

• Delport is a fixed-income investment analyst at Anchor Capital.


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