Economists widely expect the South African Reserve Bank’s monetary policy committee to once again hold the interest rate at 8.25% when it concludes its meeting on Thursday.
In yet another sign that inflation has bolted, consumer prices in the United States accelerated 9.1% year-on-year in June.
The uptick in the US inflation, which increased at its fastest pace since a 1981 recession, is just one example of the crisis that has befallen a number of advanced economies, which have struggled to rein in the runaway prices they once deemed transitory.
Elevated inflation has prompted a number of central banks to turn more hawkish in recent months, even as their economies face heightened risks of recession. But South Africa’s monetary policymakers got ahead of the inflation curve — a strategy that some economists say may have saved consumers from a more severe crunch down the line.
When the South African Reserve Bank first raised interest rates from their 2020 low last November, four months before the US Federal Reserve sanctioned lift-off, it faced the ire of critics who said it was throwing cold water on the country’s already glacial economic growth. Higher interest rates are a burden on consumers, who have to spend more on servicing their debt.
Targeting
“The Reserve Bank’s monetary policy is a critical instrument for development and the Reserve Bank should align its policy to broader macroeconomic policy objectives that far outweigh the inflation targeting,” labour federation Cosatu said. “Its mandate cannot just be limited, only, to keeping inflation under control, but it also needs to focus on supporting economic growth and job creation too.”
The Reserve Bank aims to keep inflation between 3% and 6% to ensure price stability and protect the value of the currency. The bank’s monetary policy committee (MPC) opted to hike rates during the three meetings since last November, despite inflation sticking within that range.
But Reserve Bank governor Lesetja Kganyago has proven less tolerant to prices accelerating towards the 6% mark, favouring to keep inflation anchored at the 4.5% midpoint of the target range. In May last year, consumer inflation exceeded 4.5% for the first time in over a year, and it has floated at or above that midpoint ever since.
According to Citibank economist Gina Schoeman, since the Reserve Bank has targeted the midpoint it has managed to keep inflation expectations down. Expectations, such as the oil price and the exchange rate, influence inflation as businesses adjust their prices accordingly. Adjustments made off the back of inflation expectations have a tendency to become entrenched.
“Before, inflation expectations were always anchored around 6%. And the beauty of anchoring expectations at the midpoint is that it gives you a lot more room to tolerate inflation when it starts rising, so you don’t have to hike aggressively,” Schoeman noted.
Managing expectations
In May, the MPC hiked the repo rate, which affects the cost of borrowing, by the highest increment since 2016. The 50 basis point hike came after it became clear inflation expectations were becoming unanchored.
With inflation now well above the Reserve Bank’s 6% upper limit, analysts are expecting the MPC to raise the rate by another 50 basis points when it meets next week — a move it may well catch flack for again, especially as prices are being driven by imported costs rather than by demand.
After the previous monetary policy meeting, Cosatu said that although it acknowledges that price stability is important “we feel that for an economy that suffers from large external shocks, depressing demand through interest rate hike does not make sense. Using the interest rate when the main driver of inflation is not demand but rather the skyrocketing oil prices, which translate into high food prices, commodity prices and speculative exchange rate fluctuations alone will not help the situation.”
But some analysts believe there is merit in the central bank’s plan to get ahead of the inflation curve, hiking rates more aggressively, before expectations start to weigh on the economy. By implementing steeper hikes now, it may avoid having to do so in the face of a domestic recession.
“Inflation is toxic to South Africa, given that two thirds of GDP is made up by the consumer. And most of consumer spending comes from real disposable incomes,” Schoeman said.
“So inflation can very quickly erode consumer income as well as GDP growth. Not just that, but high inflation is toxic to low-income individuals, because so much of their expenditure is towards food and fuel.”
Credibility
It is important that the Reserve Bank maintains price stability, Schoeman added. “It is vital for growth. It is vital for social stability. It is vital for creating an investment environment.”
The credibility of South Africa’s monetary policy has served as an important credit strength in ratings agency assessments.
At 6.5%, South Africa’s inflation rate is low compared to that in the US, where the Federal Reserve tolerated elevated prices far longer on the understanding that they would be transitory. Now, as the Fed finds itself behind the curve, it will have to hike its rate more aggressively and risk sending the US economy into a recession.
The Fed’s failure to act sooner risks it losing the public’s trust to bring inflation to heel. According to the minutes of the June federal open market committee meeting, there was a significant risk that inflation would become entrenched “if the public began to question the resolve of the committee to adjust the stance of policy as warranted”.
Lullu Krugel, the chief economist at the PwC South Africa, noted that central banks have had a large role to play during the current crisis insofar as managing inflation expectations.
“Our Reserve Bank has been extremely open and clear about what they do. One of the very important factors is inflation expectations and they realised that very early on … They have been very open in communicating their plan and I do believe it has played a massive role,” she said.
Krugel added that inflation targeting has helped central banks to react effectively to soaring prices and prevent them from reaching the same levels they did during the 1970s oil crisis.
Stimulating economic growth is not the Reserve Bank’s primary mandate, Krugel said. “It is the role of policy, and fiscal policy in particular, to stimulate growth and to be the expansionary measure in the economy.”
She noted that, compared with the US — which has already seen inflation become broad-based — South Africa may be in a better position to pull back runaway prices.
If oil prices do not come down, there is little the Reserve Bank can do, she added. “But what the Reserve Bank has tried to do to some extent is to try to get ahead of the curve, manage the exchange rate and in that way manage inflation. So we have a bit of an easier dilemma to unravel … And I am hoping that means that the moment the supply pressures are released, we will also see inflation subside.”
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