EDITORIAL: The jury is out on what kind of hawkish the MPC will be

“Markets capitulate to Federal Reserve on interest rates after months-long stand-off,” read a Financial Times headline a few weeks ago. Markets have finally conceded that it’s proving tougher than expected for the Fed to get inflation down by that “last mile” towards the target, with the US economy still powering along. In January, the market was pricing in six to seven 25-basis-point interest rate cuts this year. Now that has finally subsided to about three cuts — which is what the Fed itself has been saying.

Whether those cuts will start in June, July or later this year, and whether there will indeed be three of it, is becoming increasingly unclear. That could mean the dollar will stay stronger for longer than most had expected. That in turn means capital flows to emerging markets will stay under pressure, as will their currencies. 

All of which should make for an interest monetary policy committee meeting this week. It’s not that anyone is expecting SA’s first interest rate cut soon. This meeting is expected to hold rates again, as is the committee’s May meeting, which happens to be timed in the week of SA’s 29 May elections.

The Fed stance is one of the big issues the MPC will be watching. The election is another. In theory, if it were justified by the inflation outlook, the committee could start cutting rates before the Fed. In practice, that is highly unlikely, because the prospect of a stronger-for-longer dollar poses such a significant risk to the rand exchange rate and hence to inflation. The committee will want to be much more certain about the Fed’s intentions before it even signals rate cuts. It will also want to be a lot clearer about the outcome of SA’s election, which is another big risk factor for the rand. 

There is also much to worry the committee about the inflation outlook itself. It targets the future, not the past, so in that sense the monthly consumer price inflation figures are irrelevant to the MPC’s decisions. It will be making these based on the Reserve Bank’s own detailed forecasts. The latest CPI figures, which show inflation came in higher than expected at 5.6% in February, are not necessarily a concern. They reflect higher fuel prices, which the Bank will already have factored in.

It may also have factored in the big driver of February’s unexpected jump in inflation, which was the steep increase in the cost of medical aid, which is surveyed only twice a year. However, to the extent that the latest monthly data suggests something unexpected might be happening, the Bank might look again at its own inflation forecasts. That is particularly so because core inflation was up more than expected on a monthly basis, and is now back at 5%. The committee watches core closely as a measure of underlying inflationary pressures in the economy. 

Target range

It watches inflation expectations even more closely. Businesses and trade unions calibrate their price or wage demands to what they expect inflation to be and that then influences the inflation outcome. The Bureau for Economic Research quarterly expectations survey of businesses, trade unions and market analysts is therefore a crucial indicator for the committee. And the latest survey contains good and bad news. It shows average expectations have reduced by 0.3 percentage points. But it is still well above 5% for this year and for the next two years: only the analysts believe inflation will go below 5% in 2025 and 2026.

This will surely be a concern for the committee. It has made it clear it is targeting the 4.5% midpoint of the inflation target range. The over-5% expectations of SA’s key economic actors may be within the 3%-6% target range but it is still well above the Bank’s effective target of 4.5%. The committee has made it clear it will not contemplate embarking on a rate cutting cycle before it is sure that inflation is headed down towards 4.5%. 

It’s probably safe to expect that the committee’s next move will be down, not up. But when that will be is the big question. No-one expects that this week’s meeting will yield anything but a hold. As always though, what the committee says will be as important as what it does. The rhetoric is likely to be hawkish. Will it be the kind of hawkishness that signals a first July cut, or a September cut, or no cut at all in 2024? It’s anyone’s guess.