The interest-rate decision due on Thursday is not as straightforward as some hawks proclaiming a narrow-minded approach in terms of the inflation target mandate would proclaim, says Johan Rossouw, chief economist at Vunani.
“In fact, understanding the monetary policy committee’s [MPC] interpretation of its mandate is of critical importance,” he says.
Rossouw points out that the South African Reserve Bank states in its Monetary Policy Review of November 2003: “In principle, the inflation-targeting policy rule suggests that interest rates should be set on the basis of the divergence of the central forecast from the inflation target.
“Thus if the forecast for inflation up to the policy horizon (around 18 months to two years) is above the inflation target, interest rates should be raised and if it is below, interest rates should be reduced.”
Rossouw adds: “Clearly, even ignoring mitigating factors like the fact that regulated prices are contributing significantly to higher inflation, the quote above suggests that there isn’t sufficient grounds for further interest-rate tightening.”
He says his base-case forecast points at CPIX levels below the upper limit of the target range over 18 months to two years forward.
He adds: “The final part that seals the rate decision, as far as we are concerned, reads as follows: ‘However, in reality, although this rule does guide policy formulation, the MPC does not follow it in a mechanical way.'”
Rossouw says: “Clearly, had the forecast for CPIX been outside the target range over the 18-months-to-two-year window, it would not necessarily have implied a rate hike.
“Moreover, given prevailing conditions and the rapid deterioration in the financial health of the consumer, the MPC runs the risk of doing more harm to the economy by hiking interest rates at this stage than by leaving it unchanged.
“Regarding the issue of reputational risk to the bank should it not hike rates, we are of the opinion that the bank stands to win more credibility by applying monetary policy pragmatically than by simply hiking interest rates dogmatically.
“In any event, such a decision would not be a deviation of the stance taken at the previous meeting, even though the bank might come across a little bit more hawkish.”
Rossouw concludes: “Consequently, while the risk of further rate tightening at this week’s MPC meeting has certainly increased, we remain of the opinion that a decision to keep the repurchase rate unchanged rather than to hike will prevail.” — I-Net Bridge