Dependence on the data – and the inflation forecasts – mean there is no case for raising the repo rate now , nor maybe for another 12 months or longer
There would seem to be no reason at all for the Reserve Bank to raise its repo rate tomorrow. Investec Securities, applying its own simulation of the Reserve Bank forecasting model, predicts that the Reserve Bank forecast of inflation will have been unchanged ahead of the MPC meeting. This simulation is for inflation to average 6.2% for 2014(largely behind us now), 5.7% in 2015 and 5.8% in 2016. Thus inflation is predicted to come in below the upper end of the target range.
While this small margin of safety in the inflation outlook may not provide much room for comfort, the state of the economy should provide even less reason to wish to raise rates. The latest data releases (to September month end) on retail sales volumes and money and credit, suggest that household spending and borrowing remain subdued. Growth in retail sales volumes appears to be trending lower and mortgage lending by banks- both household and commercial still appear s to be stuck in a slow growth band.
There is no pressure on prices coming from the demand side of the economy. Indeed the lack of demand must be regarded as more a problem for the Reserve Bank. The CPI to October 2014 hasd just been updated today and came in in line with consensus forecasts at 5.9%. Changes in the CPI over the past three months, converted into an annual rate, have turned sharply lower.
The main forces holding up the inflation rate to date, given the very subdued state of demand for goods and services, have been the constant upward pressure of government administered prices (electricity, water and their like) and the exchange rate that raises the prices of imported goods and goods and services. The better news is that while the rand has weakened against a strong US dollar, on a trade weighted basis, the foreign exchange value of the rand is unchanged this year. It weakened sharply last year as we show below.
Moreover the strong US dollar is helping to hold down the US dollar prices of most commodities, notably oil, copper and steel, as well as the imported staples, like rice and wheat, the domestic prices of which are based on the cost (including transport costs) of landing imports. Maize by contrast is export parity priced and bumper harvests have seen its domestic price fall very sharply this year. If current exchange rate and global price trends are sustained, the outlook for inflation will improve.
The threat to the rand might well come from higher US interest rates. An improved interest rate spread in favour of US interest bearing assets is a reason for selling other currencies and buying the US dollar. Such trends have been at work this year. Slow growth and fears of deflation in Europe have held down interest rates there, while the consistent recovery in the US economy has helped keep up rates there all along the yield curve. This has kept up the interest rate spread in favour of the US dollar.
Given this spread in favour of US Treasuries it seems likely that the US dollar will continue to command fund flows from abroad to support or improve its value against most currencies, including the rand, the euro and the other currencies exchanged for the rand. Dollar strength (more than rand weakness) may well mean further deflationary pressure on commodity prices, bringing less pressure on the SA CPI from higher import prices. If this turns out to be the case, there would be no reason to raise local rates even were the authorities confident that higher short rates would protect the exchange rate. The evidence suggests that any such confidence in the ability of higher rates to support the rand would be misplaced.
What can be confidently predicted is the influence of interest rates on spending by households and by firms on their plant, equipment and workforces. Higher rates will mean slower growth and will undermine the incentive to invest in SA enterprises, so possibly weakening rather than helping the rand.
Among the developed economies only in the US, with its recovery prospects seemingly secure, can higher short term interest rates be predicted with some confidence. The rest of the developed world, and much of the emerging world, including China, will likely be looking to more accommodating monetary policy, given an unsatisfactory growth outlook. Higher interest rates will not easily be imposed or tolerated until the growth outlook improves.
SA should be in this camp and should react accordingly. It will make little sense to follow US rates higher. A stronger US dollar should be tolerated – this will not necessarily mean more inflation as the dollar prices of the goods and services SA imports and exports remain under pressure. A strong dollar and thus less inflation in the US may well mean a shallower path of interest rate increases by the Fed.
