ARTHUR KAMP: Inflation remains enemy number one

The SA Reserve Bank’s monetary policy committee (MPC) has remained true to its inflation targeting mandate by increasing the Bank’s repo rate by 75 basis point to 6.25% per year at the conclusion of its September 2022 meeting.

Near-term constraints on economic activity, brought on by weakening global growth and severe domestic electricity supply disruptions, must have provided pause for thought. Nonetheless, it is telling that whereas three members of the committee voted for the 75 bps increase, two members preferred an increase of 100 bps. Clearly, inflation remains enemy number one.

At the same time, since the MPC statement notes the “revised repurchase rate path remains supportive of credit demand in the near term” it seems the Bank is comfortable that its policy stance is not overly restrictive.

In reaching a decision the MPC members could not ignore the aggressive interest rate hiking cycle of the US Federal Reserve. Importantly, the Fed’s updated economic projections, released this week, show an even more aggressive expected interest rate hiking path relative to the previously published forecast.

The median projection of Federal Reserve board members and  presidents for the funds rate is now 4.4% at end-2022 and 4.6% at end 2023. This compares with the Fed’s June 2022 median projection of 3.4% at end-2022 and 3.8% at end-2023.

The relative tightening of US monetary policy and the accompanying sustained strength of the dollar is weighing on the currencies of emerging market economies. As the MPC statement notes, this is an environment in which tightening global financial conditions “raises the risk profiles of economies needing foreign capital”. SA is one of these economies.

To be clear, the Reserve Bank does not target the rand specifically. However, it can be expected to act if it is concerned that currency depreciation could spill over into higher inflation expectations, raising the risk of second round inflation effects.

Importantly, in this regard, the MPC statement notes the average of surveyed inflation expectations increased to 6.5% for 2022 and 5.9% for 2023 — well above its inflation target of close to 4.5% (the midpoint of its inflation target range).

Higher inflation expectations tend to result in higher wage demands. Households will, after all, try to avoid erosion of their income in real terms. In turn, if higher wage growth is not accompanied by stronger productivity growth, the risk is the development of a wage price spiral.

The question now is how much higher the repo rate is likely to go from here. The Bank’s Quarterly Projection Model (QPM) forecasts a repo rate of 5.6% at end-2022, 6.36% at end-2023 and 6.76% at end-2024. However, this projection is merely a guide and the MPC members are not bound by it.

Ultimately, one hopes front-loading the interest rate hiking cycle will help dampen inflation expectations and increase the likelihood of the Reserve Bank meeting its inflation target in the medium term. 

However, forecasting the future is hazardous and any number of developments could alter the outlook. Indeed, the Bank still assesses the risk to the inflation outlook is on the upside. Much will also depend on the future path of the Fed’s funds rate and the relative strength of the dollar.   

Encouragingly though, the Bank’s QPM forecasts a slowdown in headline consumer price inflation to an average of 5.3% in 2023 and further to 4.6% in 2024, from an average of 6.5% in 2022. Note, too, the forecast for 2023 has been lowered since the previous MPC meeting (when the model projected average inflation of 5.7% for next year). 

If this projection is realised it seems reasonable to argue that much of the heavy lifting has probably been done, though by no means all.

• Kamp is chief economist at Sanlam Investments.