The Reserve Bank, not before time, has changed its tone. It has suggested that the interest rate cycle may have peaked. From the pause in the trend to higher rates we now have talk of a longer pause in interest rate settings. If the exchange rate holds up better than R14 to the US dollar by the next time the Monetary Policy Committee (MPC) meets in November, interest rates may well be on their way down. The Bank’s inflation forecast (if not the year on year change in the CPI, headline inflation itself) will have had time to adjust lower and food price inflation will be in retreat from its extraordinarily elevated 12% plus base. How rapidly this occurs will depend on the rain. Prayers for rain are in order.
If all goes better on the inflation front, the Reserve Bank will be able to focus on something very important to the SA economy over which it does have considerable influence and that is domestic spending and lending. Its interest rate settings do predictably affect the willingness of households and firms to spend more; and the SA economy urgently needs the stimulus of more demand and lower interest rates.
These interest rates however have no predictable influence on the exchange rate, rainfall or on excise and other taxes, including fuel and sugar taxes. Nor do they affect the price of electricity except, perversely, should Eskom persuade Nersa, the regulator, that its higher borrowing and other costs are a good (actually bad) excuse for a higher tariff. Nor, as I would argue, though the MPC would disagree, do higher interest rates influence inflationary expectations for the better and/or wage demands for the better.
Inflation expected (which has remained remarkably stable and consistent around the 6% – the upper band of the inflation target level will follow inflation – not the other way round. Inflation leads and inflation expected follows, as will be further demonstrated should inflation come down because the rand has strengthened and long term interest rates decline relative to US interest rates, meaning less rand weakness expected and hence less inflation expected. This narrowing of the spread between RSA and US benchmark interest rates has been under over the past few days. It is a very helpful development.
With some help from global capital flows, the weather and the politicians (and also the rating agencies) we will see the rand hold up inflation and the inflation forecasts continue to recede. The question then will be how low can interest rates in SA go. I would suggest as low as it takes to get the growth in spending running at a sustainable 3- 4% per annum. The sustainability of such growth will depend upon support from capital inflows and so a stable rand itself. Faster growth itself will be very encouraging not only to capital expenditure by firms and the government – but to global suppliers of capital. Can we dare hope for a virtuous cycle of faster growth with less inflation? A reprise perhaps of 2003-2008, accompanied by much better control of money supply and bank credit?