The Monetary Policy Committee (MPC) of the Reserve Bank will be reporting back today on its first meeting of 2015.
The MPC did not have a good 2014. By the year end it had become clear that it had overestimated both SA inflation and growth in 2014 and beyond.
The estimates of inflation were overtaken by events outside SA, over which the Reserve Bank has no influence. These were events that moved global prices and interest rates markedly lower and the rand no weaker on a trade weighted basis, despite the strong US dollar. However the increases in the MPC short term repo rate in 2014, to 5.75%, by an initial 50 bp in January followed by a further 25bp in July, would have discouraged domestic spending to a degree. This was spending that in mid year gave every indication of slowing down even more rapidly than initially forecast. But the higher cost of credit had no discernible influence on inflation, dominated as it was by global price trends, especially that of oil and grains, and the exchange rate.
Hindsight would suggest that short term interest rates in SA should at worst have been kept on hold in 2014 and, better still, should have moved lower. Longer term rates certainly did, determined as they are by market forces, though they were market forces with an eye always on central bank action.
The Reserve Bank might be inclined to contest such an observation. It stressed in its statements released after its MPC meetings that fighting inflation was its primary task and moreover that it regarded its monetary policy as always accommodating, a reference to the unusually small gap between interest rates and inflation.
According to its statement in July 2014, when it raised short rates by a further 25bp:
“The MPC is also increasingly concerned about the inflation outlook, and the further upside risks to the forecast. Although the exchange rate remains a key factor in this regard, the possibility of a wage-price spiral should wage settlements well in excess of inflation and productivity growth become an economy-wide norm has increased. Although the inflation trajectory has not deteriorated markedly since the previous meeting, upside risks have increased, and it is expected to remain uncomfortably close to the upper end of the target range when it does eventually return to within the target. The upside risk factors make this trajectory highly vulnerable to any significant changes in inflation pressures.
“Although inflation expectations have remained relatively anchored, should inflation persist outside the target band, these expectations risk becoming dislodged.
“The MPC has decided to continue on its gradual normalisation path and raise the repurchase rate by 25 basis points to 5,75 per cent per annum, effective from Friday 18 July. Given the expected inflation trajectory, the real repurchase rate remains slightly negative and well below its longer term neutral level. The monetary policy stance remains supportive of the domestic economy, and, as before, any future moves will be gradual and highly data dependent.
“We would like to reiterate that monetary policy should not be seen as the growth engine of the economy. The sources of the below par growth performance are largely outside the realms of monetary policy.”
The lesson the Reserve Bank might however take from events in 2014 is that while it is true that the “the sources of the below par growth performance are largely outside the realms of monetary policy”, so is the inflation rate.
Inflation in 2015 will continue to be dominated by events beyond the influence of SA monetary policy and short term interest rate settings. For some obvious examples of only the known unknowns, the timing of the first US FED rate increase, June 2015 or later, will matter for global growth and inflation forecasts. So will the success or otherwise of European quantitative easing and how deflation in Europe presses down euro yields and hence the flow of funds both to the US and emerging markets (including SA) in search of higher yields. A possibly still stronger dollar might press further on the oil and other metal prices, meaning less inflation and possibly slower growth in the US. The economic recovery in the US, depending on its pace, may encourage tepid growth in emerging economies, adding to the attractions of their equities and currencies, including the rand. Such outcomes will in turn bring rate increases in the US either forward or back.
The MPC, as is clear from the statements it issued, worried a great deal in 2014 about the turbulence in global markets and economies and how it should react to the interest rate decisions of other central banks. As it turned out, the higher rates imposed by a number of emerging market central banks, including the SA Reserve Bank, were ill advised and are being reversed in the light of lower inflation.
The MPC will almost certainly keep its repo rate on hold today. Hopefully its future decisions will remain data dependent and not presume a so described normalisation of interest rates any time soon. Normalisation of (higher) interest rates presumes a normalisation of global economic circumstances that remain distinctly abnormal as deflation and QE in Europe confirm.
It would be wise for the Reserve Bank to realise that its influence over growth, inflation and inflation expectations is limited given the exposure of the SA economy to global forces.
There is however one feedback loop over which it has some influence. This is the loop from short term interest rates to domestic spending. Higher rates discourage such spending and lower rates can encourage it. This is the only channel of influence the Reserve Bank can rely upon to some degree.
It should therefore concentrate on ensuring that domestic demand neither adds to nor detracts from inflationary or deflationary pressures. Or, in other words, to attempt with its interest rate settings to match domestic spending (influenced as it will be by bank lending) to potential domestic production as closely as possible. If it succeeds in this, it will have done what little it can realistically hope to achieve in consistently low inflation in SA. Hoping to do more than this, especially in hoping to predict the course of global economic events, and then to react “correctly”, is beyond its limited powers. This was amply shown to be the case in 2014.
Domestic spending in SA has been running at what can be presumed to be well below normal levels and rates of growth. It can do with all the help it will be getting from lower inflation and lower fuel prices. Additional help from lower short term interest rates may well be called for in due course, if spending growth remains subdued.