ARTHUR KAMP: A question for the Reserve Bank’s MPC: are we there yet?

Despite cutting its GDP growth forecast to just 0.3% for 2023 from 1.1% previously, the Reserve Bank felt compelled to hike its repo rate a further 25 basis points (bps) to 7.25% at the conclusion of its January monetary policy committee (MPC) meeting.

The hike was significantly smaller than the 75 bps increase implemented in November. The Bank nonetheless remains concerned about upside risks to the inflation outlook, amid sticky, elevated inflation expectations.

Indeed, two of the MPC members preferred a more aggressive 50 bps interest-rate hike, while the committee’s statement noted future interest rate decisions would be data dependent. This leaves the door ajar for another interest rate hike in March, if the Bank deems it necessary.

Among all the data points considered, the MPC members must have been especially displeased with the uptick in inflation expectations recorded in the Bureau for Economic Research's fourth-quarter inflation expectations survey, which showed an increase in expected inflation from 5.9% previously to 6.1% for 2023 and from 5.3% previously to 5.6% for 2024.

This was at least partly counterbalanced by a decrease in long-term inflation expectations derived from the yield differential between conventional and inflation-linked bonds, which decreased to 4.95% from 5.27% at the time of the November MPC meeting for the five-year breakeven.

In continuing its interest-rate-hiking cycle despite the dismal growth outlook, the Bank has once again demonstrated its unwavering commitment to its inflation target. After all, monetary policy is not the cause of SA’s ultra-low potential growth rate.

The culprits are failing infrastructure, including ongoing electricity load-shedding, policy uncertainty and an unsustainable fiscal policy. The last of these has pushed up real interest rates and crowded out private-sector investment.

However, the heavy lifting has been done. In 2022 the MPC embarked on an aggressive front-loaded interest-rate-hiking cycle aimed at curbing the second-round inflation threat from the spike in food and oil prices. By and large it appears to have succeeded.

Inflation is likely to have peaked and is expected to slow materially towards the midpoint of the Bank’s inflation target range by year-end. Thereafter inflation is forecast to average 4.8% and 4.5% in 2024 and 2025 respectively.

Even though expected disinflation in 2023 mostly reflects the high base established in 2022 and lower fuel price inflation, lower soft commodity prices should help to limit the potential for further second-round inflation effects.

Encouragingly, the annual advance in core inflation slowed to 4.9% in December, from 5% in November, following a monthly increase of just 0.2%. 

At the same time, given dismal GDP growth expectations, there is no pressure from an overheating economy. The expected output gap for 2023 is close to 0%.

It is worth noting that at 7.25%, the repo rate is now above the repo rate projection of 7.08% for year-end 2023 and 6.91% for year-end 2024 produced by the Bank’s Quarterly Projection Model (QPM). The model’s output shows the expected level for inflation and growth, which is consistent with the QPM’s repo rate projection.

Admittedly, the MPC members are not bound by the QPM. However, it does provide a strong anchor in considering the appropriate level for the repo rate. The committee would not want to drift too far away from this estimate, ostensibly.   

The economy is constantly exposed to shocks and predicting the future is fraught with risk. The US Federal Reserve may hike more than expected, which could hurt the rand and push domestic inflation expectations higher. Alternatively, economic recovery in China may lift commodity prices and overall inflation once again.

However, the best we can do is provide a view of the repo rate based on current information and projections for growth and inflation, which suggest that we are at (or very close to) the top of the interest-rate-hiking cycle.

The Reserve Bank’s MPC should consider a pause after at most one more 25bp hike, if any.

• Kamp is chief economist at Sanlam.