Bank’s decision on rates could signal a policy shift
IN 2010, Reserve Bank governor Gill Marcus said: "If inflation is expected to remain within the target, monetary policy will have greater flexibility to focus on growth issues — particularly when the growth rate is below potential. This is entirely consistent with a flexible inflation targeting environment."
This was not a new statement then, nor a departure from the monetary policy pursued under the previous governor, Tito Mboweni. When inflation is expected to remain within the target band for the forecast period — which runs perpetually six to 18 months into the future — the Bank is likely to lower interest rates if poor economic conditions warrant it.
The unexpected cut in the repo rate in July may be explained by expanding this view to include expected weak economic conditions. The Bank certainly lowered its inflation expectations in July, and economic growth is — and is expected to remain this year — below the potential the economy could achieve if all its resources were employed. Expanding this definition of full employment of resources to include all those who wish to be employed would signify a new monetary policy paradigm.
It should be noted that existing exogenous price pressures (recent high international maize and wheat prices) may cause the Bank to raise its inflation expectations for 2013, by about 0.5% at the September meeting of its monetary policy committee. South Africa’s white maize price is at record levels, mainly because of the recent steep ascent in international maize prices and the future contract prices.
There is also concern that South Africa may export too much maize this year — grain stockpiles are foreign owned — resulting in the country having to import to meet its own needs. The international prices of maize and wheat have risen sharply after severe drought in the US and poor weather conditions in Russia damaged crops.
The latter has also prompted concern that the country might institute export restrictions on its wheat. Indeed, price pressures are spreading to other crops that will become affected if weather conditions do not improve.
International maize prices are expected to peak by the end of the year, with the price dropping significantly in 2013 on increased planting in the US and anticipated better weather conditions, which could see a reduction in this cost-push pressure.
Much of the damage that could occur in the US has already been inflicted on the corn crop. Consequently, many US meat producers are now looking to buy corn at the current high price, having delayed purchases in the hope that weather conditions would improve — forecasts indicate this is unlikely — and maize prices fall.
Higher maize prices will then push up meat and dairy prices, and ethanol production would also be affected by maize shortages.
Indeed, the close relationship between international and domestic maize prices — with domestic producers always selling to the highest bidder — means that CPI inflation is likely to rise in South Africa.
The domestic bread and cereal price inflation rate, which includes grain products, in index tends to follow that of international maize prices — albeit with a few months’ lag, as domestic maize prices follow international corn prices. This means food price inflation should climb in the second half of the year, pushing up the inflation rate targeted by monetary policy.
South Africa’s CPI inflation rate dropped from 6.1% year on year in April to 5.5% year on year in June, as food price inflation declined from 9.1% year on year to 6% year on year. This faster-than-expected decline in the headline inflation rate prompted the Bank to cut interest rates unexpectedly in July — the market was expecting a cut of less than 10 basis points the 50 basis points that transpired.
This means neither the markets nor the economic consensus was not factoring in the cut either. The decline in South Africa’s inflation rate in the second quarter that prompted this interest rate cut was, in fact, due to a fall in the inflation rate of bread and cereals (grains including wheat and maize products), from 10.6% year on year from 6.9% year on year.
Clearly this moderation in food price inflation would be reversed if maize and wheat prices continue to climb substantially, which may reduce, if not eliminate, the probability of a further significant decline in inflation by year-end.
Already, the June producer price inflation rate for grain prices has jumped to 15.9% from 8.9% in May and is expected to accelerate further. The lag between the agricultural and manufactured grain price inflation rate was recently at two months, which means manufactured food price inflation for grain-mill products is likely to rise from August.
There does not recently appear to be a lag between manufactured food price inflation for grain-mill products and consumer price inflation for bread and cereal prices, which means the last quarter of this year could see food price inflation track up noticeably, continuing into the first half of 2013, particularly as grains are used in animal feed and so affect meat and dairy prices.
Inflation in 2013 could come out at 5.5% instead of the current expectations (including the Reserve Bank’s) of 5%. But 5.5% is still within the 3%-6% inflation target, and a 50-basis-point interest rate cut in September could still occur as South Africa’s economic growth rate will definitely be below potential at that time.
The definition of potential growth could even be expanded so that the governor’s statement in the first paragraph means interest rates would be cut if inflation were expected to be below 6% year on year and the rate of unemployment high.
In other words, the Bank may be making use of prevailing conditions of global and domestic economic weakness to move to a structurally lower interest rate environment in South Africa. This would align with lowering the cost of doing business in South Africa and focusing on reducing poverty and unemployment.
The governor also said in 2010 that any "sustained further appreciation of the rand exchange rate" would meaningfully lower the inflation outlook, thereby allowing the Bank to cut interest rates.
The advent of a third round of quantitative easing in September has become more likely with the most recent FOMC (Federal Open Market Committee, the interest-rate-setting body in the US) minutes saying some of the committee is "favouring or willing to consider additional easing if conditions weaken". The FOMC statement has been taken to mean that the US may engage in quantitative easing by September if the unemployment numbers do not improve.
As occurred previously, quantitative easing is likely to cause the rand to strengthen substantially — which could either lower, or keep, the Bank’s inflation expectations, engendering another cut as economic growth remains below the potential it could achieve if all resources are employed.
Could a greater focus on reducing South Africa’s unemployment by structurally lowering the interest rate — creating a new monetary paradigm? Or a co-ordinated global monetary policy? The Bank’s interest rate cut in July was in line with the easing in many other countries and a third round of quantitative easing. If it occurs, it will be monetary policy easing, given that the world’s largest economy is experiencing ZIRP (or zero-interest-rate policy).
The UK and eurozone are also likely to make their monetary policy more accommodative if a third round of quantitative easing occurs.
All in all, a further 50-basis-point cut in interest rates this year cannot be ruled out.
More in this section
- Central control of lottery looms
- IN THE MARKETS: Amcu leaders deny responsibility for new strike
- We need new leaders to turn SA around
- SA-Nigeria co-operation can benefit all of Africa
- Gupta brothers are merely a symptom, not the problem
- SA must build better bridges between policy and implementation