A confident newly appointed Governor adopted a dovish tone. Correctly, but to some degree surprisingly so, with the so-described “normalisation’ of interest rates postponed, perhaps for an extended period of time depending on the data, both local and, as important, foreign developments.
The bond market reacted accordingly, pushing bond prices higher and yields lower. The big surprise to the Reserve Bank was surely the behaviour of the rand: a softer tone with a stronger rand on the day, though surprising, would have been welcomed by the MPC. It improves the outlook for inflation and also the real economy that needs all the help it can get. The risks to inflation are now regarded as balanced rather than to the upside. If inflation continues to trend lower and below the upper band of the inflation target range, the case for lower short rates will present itself. This is particularly the case if the domestic economy continues to operate below potential and the global inflation and interest rate environment remains benign.
It may well remain so despite higher short rates in the US, which presents itself as the only developed economy capable of tolerating such higher interest rates. Weakness in other developed and developing economies will make for a stronger US dollar and simultaneously lower dollar prices for the key metals, minerals and staples traded on global markets. But a weaker rand / US dollar rate may be offset on the crosses and imply much less pressure on the CPI than usual – as has been the case this year.
The reaction in the currency market – less pressure on short rates combined with a stronger rand – helps illustrate an important empirical regularity. The impact of policy determined interest rate movements on the value of the rand is largely unpredictable. It has about an equal chance of going either way. Therefore raising rates may not help reduce inflation outcomes, or reducing them increase the rate of inflation to come. What is predictable is the impact of interest rates on domestic spending. Higher rates slow down spending trends and lower rates help improve them.
On Thursday (the day of the MPC meeting) the lack of pressure on short rates extended to the longer end of the bond market. Perhaps flows of funds from offshore in anticipation of declining long bond yields moved bond prices higher and the rand stronger. We show the reactions in the bond and money market below. It can happen again: less pressure on short term interest rates with the prospect of faster growth in SA can assist the rand and promote faster growth with less inflation. Such possibilities should concentrate the mind of the MPC.
