The South African Reserve Bank is expected to cut the benchmark repo by another 25 basis points on Thursday
Considerable uncertainty — as well as the prospect of other economic shocks — have made the fight against inflation far more hazardous.
This was the sentiment during the opening session of the South African Reserve Bank’s biennial conference, where central bankers and economists are set to discuss monetary policy in the wake of the crisis induced by the Covid-19 pandemic.
The conference comes just weeks ahead of the Reserve Bank’s monetary policy committee meeting in September, where it will decide whether the country’s borrowers will get some relief or continue to endure the currently high interest rates. While the recent fall in domestic inflation would suggest an interest rate cut, speakers at the conference seemed to favour a “higher for longer” approach amid ongoing economic uncertainty.
Raphael Bostic, president and chief executive of the Federal Reserve Bank of Atlanta, noted that there are no historic models to guide central bankers through the shock of the pandemic.
“So, in important ways, we continue to operate in uncharted territory as we aim to restore economy-wide supply and demand to a pre-Covid equilibrium,” he said.
Monetary policy decisions in the US are complicated by the pandemic’s lingering effects, high corporate and government debt, Russia’s war on Ukraine and extreme weather events, Bostic said.
In the US, the annual inflation rate surged to a 40-year high towards the middle of 2022. This was after the Federal Reserve began lifting the federal funds rate in March 2022.
The Fed was widely criticised for falling behind the curve on inflation — which, despite having dropped significantly since, has still not fallen to the central bank’s 2% target — after initially describing the price spiral as transitory.
Bostic noted that the decline in US inflation has been relatively slow, adding that he expects this pattern to continue. Though data points to inflation falling to the Fed’s 2% target, the economy is still beset with uncertainty, he said. “And we cannot be completely sanguine about any projections.”
Bostic underlined the importance of “a patient, resolute and cautious approach to monetary policy”. This might entail holding policy in restrictive territory for as long as it takes to bring inflation within target. However, monetary policymakers must be careful not to overtighten, inflicting unnecessary damage on the labour market and wider economy, he said.
In June, the Fed kept interest rates on hold for the first time in more than a year. However, at the recent Jackson Hole Symposium, Federal chair Jerome Powell reportedly affirmed that interest rates would remain in restrictive territory until inflation is sustainably within target.
“I do not expect our path from here to the 2% inflation objective — the last mile, if you will — to be without curves and bumps,” Bostic concluded on Thursday.
Hauw Pill, chief economist and executive director for monetary analysis and research at the Bank of England (BoE), similarly emphasised the need for a steady hand amid uncertainty.
The BoE moved on inflation earlier than the Fed, in December 2021. However, the UK’s economy, also exposed to Brexit-related supply shocks, was hit by higher inflation. Prices have also been slower to come down. At 6.8% year-on-year, the UK’s inflation rate is still well off the BoE’s 2% target.
According to Pill, the UK’s inflation predicament is instructive of the dangers of second-round effects, which arise when inflation dynamics become embedded in pricing and wage cost-setting behaviour.
Pill noted that over the past 25 years, “inflation has been very well behaved”, whereas recently cost pressures have had an asymmetric impact on inflation. Under these conditions, Pill said he tends to favour a strategy in which policy is held in restrictive territory for longer.
Earlier this month, the BoE raised its policy rate by 25 basis points, marking the 14th consecutive hike. The central bank’s monetary policy committee noted that it would ensure that the policy rate “is sufficiently restrictive for sufficiently long to return inflation to the 2% target sustainably in the medium term”.
Giovanni Ricco, a professor of economics at the École Polytechnique in France, pointed out that there may be more shocks on the horizon — and that central banks have to be alive to these.
Ricco noted that, as a net importer of energy commodities, the euro was especially exposed to the inflationary pressures created by Russia’s invasion of Ukraine.
Though inflation in the region has come down quicker than in the UK, prices have continued to be marked by stickiness. For this reason, the European Central Bank’s governing council decided to raise the central bank’s three key interest rates by 25 basis points in July.
“Inflation continues to decline but is still expected to remain too high for too long,” the council said in its monetary policy decision.
Ricco also spoke to the economic volatility that may still arise in the wake of the climate crisis. Against this background, he said, “central banks seem to be running out of good luck”.
Good policies are harder to define and mandates are increasingly difficult to achieve, Ricco added, noting that central banks may learn a lot from emerging markets. He advised that central banks pursue a more open and less centralised academic debate.