Gill Marcus warned that monetary policy should not be seen as the growth engine of the economy.
Opinions may have been split on whether the South African Reserve Bank would hold or hike interest rates, but it was widely agreed that the decision would be a tough one.
Reserve Bank Governor Gill Marcus said as much when she announced the repurchase rate would increase by 25 basis points pushing it to 5.75% and in turn will push the prime lending rate up to 9.25%.
“The MPC [Monetary Policy Committee] faces an increasingly difficult dilemma of rising inflation and slowing growth,” Marcus said in her announcement on Thursday afternoon. “The core mandate of the bank remains price stability, but at the same time, in achieving this mandate, we have to be mindful of the impact of our actions on economic growth and tread a fine line between acting effectively to address the inflation objective, while not undermining growth unduly.”
Economists were divided on what the bank would decide and Dave Mohr, chief investment strategist for Old Mutual Wealth, for one, had not expected the hike given the weak economic growth. “It was surprising they decided to hike,” he said. “But it does seem to be in reaction to the fact that we have all this strike activity and the wage settlements are way above inflation.”
In her speech, Marcus said the committee was concerned that recent wage settlements in the mining sector – as high as 20% – and current demands in the metals sector could set a precedent for wage demands more generally.
Wage price spiral
“Unless accompanied by higher productivity, such settlements could generate a wage price spiral, and are also likely to have a negative impact on employment trends,” Marcus said. She however also noted that there is an imperative for attention to also be paid to excessive salaries and bonuses of management and executives.
The bank also revised its growth forecast downward. “The bank’s latest forecast, which assumes a speedy resolution of the metal workers’ strike, sees growth in 2014 at 1.7%, compared with 2.1% previously and 2.8% at the beginning of the year,” Marcus said. “Growth forecasts for the coming two calendar years have been reduced to 2.9% and 3.2%, from 3.1% and 3.4% respectively.”
“The MPC remains concerned about weak growth, widening output gap and the negative employment outlook. The strike in the platinum sector contributed to the downward revision of the growth forecast, and the latest forecast has not factored in the possibility of a protracted work stoppage by the metal workers, which would potentially have much wider ramifications because of the direct linkages to other sectors of the economy. This weak growth outlook, however, is not something that monetary policy can ameliorate.”
Largely decoupled rand
Marcus said household consumption as well as growth of credit extension remained weak. The rand too had largely decoupled from its emerging market peers, and depreciated relative to most currencies, as it reacted to deteriorating domestic fundamentals, she said.
“These included the negative GDP [Gross Domestic Product] growth rate, the adverse reports from the ratings agencies, and the protracted nature of the platinum and metal workers strikes.”
Inflation is now expected to average 6.3% in 2014, compared with 6.2% previously, with the quarterly peak of 6.6 % expected in the fourth quarter. “Inflation is still expected to return to within the target band [of between 3% and 6%] during the second quarter of 2015 provided that there are no further shocks to the system, particularly from possible higher tariff increases being granted to Eskom by Nersa [the National Energy Regulator] from 2015.”
The only titbit of good news Mohr said was that agricultural producer price inflation declined from a recent peak of 13.3% in March, to 6.7% in May reflecting in part the sharp decline in maize prices to export parity price levels – thanks to a bumper crop.
The Reserve Bank’s main job is to keep inflation as close as possible to the target range, said Mohr. And the hike rate was likely because they want to reinforce the message: “they will look at inflation first and would be the most important factor in deciding on interest rates and to enforce that we are in rate hike cycle,” he said. “They had to do something to convince the public that they won’t let inflation run away.”
Marcus warned that monetary policy should not be seen as the growth engine of the economy and the sources of the below par growth performance are largely outside the realms of monetary policy.
“In the short term, an improvement in the interaction and relationships between management and labour is essential to foster a climate of trust and confidence, and get South Africa back to work,” she said.
Given that the key headwinds preventing a return to trend growth are structural, there is an urgent need to implement necessary structural reforms, as envisaged in the National Development Plan, in order to achieve higher and more inclusive growth.”