To raise or not to raise? The issues the SARB must grapple with to make its decision
At times like these, I feel grateful that I am not a member of the Reserve Bank Monetary Policy Committee. The MPC, with its seven members, is the independent body that decides at what level to set South African interest rates.
The MPC must balance a few competing demands. On the one hand, its mandate it to keep inflation at between 3 and 6%, so when inflation is near or over the top of the band (it's at 6.1% right now), the Reserve Bank is likely to raise rates to reduce inflation. On the other hand, the MPC must also consider issues of economic growth and employment. South Africa's unemployment rate recently ticked up above 25%, and there are many indicators suggesting that economic growth is slowing – retail sales are weak, for example, and manufacturing numbers have also been tepid. This puts pressure on the Reserve Bank to lower or maintain rates. It's a really tough call, and I'm glad I don't have to make it. – FD
ALEC HOGG: Welcome back to Power Lunch. The previous meeting of the South African Reserve Bank's Monetary Policy Committee in March, resulted in the repo rate being left unchanged at five-point-five percent, but it was not a unanimous decision. Three of the seven committee members voted for a hike, and four against. Joining us now to discuss what we can expect on the next MPC – and we'll be hearing all about that tomorrow, although they're actually meeting today – is Izak Odendaal. He's and Investment Strategist at Old Mutual Wealth. Izak, 4-3 was the vote last time. Things have gotten, I guess, a little worse since that. Are you looking for an increase in interest rates tomorrow?
IZAK ODENDAAL: I think the fact that it was four out of three, signifies how difficult the decision is and how difficult it was in March. It's not going to be any easier tomorrow when they announce the outcome. They're obviously meeting at the moment. What we need to remember is they try to forecast inflation 18 months to two years ahead. The question is, has their inflation forecast changed since March? I don't think it has. If anything, it might be slightly better if you consider that the Rand has strengthened and prices have come down significantly, so there are some factors that would point to a lower inflation forecast. If they didn't hike on the inflation forecast in March, then that would suggest that they might not hike tomorrow. Of course, the economic indicators have all worsened substantially.
ALEC HOGG: The problem of course, is that we had inflation today (or CPI today) coming out above the Rand at six-point-one percent. Might this not influence them?
IZAK ODENDAAL: Again, the question is what was the forecast? They absolutely expected inflation to lift above that six percent target. They're expecting inflation to average about six-point-three percent this year, peaking at six-point-six in the fourth quarter, and then averaging below six next year. From that point of view, they can be fairly comfortable that the rate hike in January might be enough, although the MPC has also been at pains to suggest that this is a rates hike cycle, so we shouldn't expect rates to remain flat over the course of the next year to 24 months. However, they might not necessarily hike tomorrow. I think they will place quite a lot of weight on the fact that the local economic numbers have been poor all the way across mining, manufacturing, retail, and vehicle sales. Those numbers have all been quite poor and the outlook for the local economy is a bit like the weather in Cape Town today. It's moody.
ALEC HOGG: Yes, it is a conundrum, a little bit of a conundrum given that we're back into a rising interest rate cycle and it might be there for years if the United States does what it has to do, and pulls money out of the economy. Izak, earlier we spoke to Annabel Bishop. She's the Chief Economist at Investec. Let's have a look at what her predictions were for the next decision, which as you said we'd hear about tomorrow.
ANNABEL BISHOP: I'd be comfortable with six percent, because it's what is expected. If it ticks up to six-point-two (or heaven forbid, higher than that), we'll actually move towards a six-and-a-half percent mark. That said, it's historical and this is really the point. They can only target inflation 12 to 24 months after, with any effectiveness. Even up to the six to 12-month mark, you have limited impact on inflation, so hiking interest rates substantially now is not going to have any impact on past inflation outcomes or indeed, for the rest of this year. They're going to have to focus on what other drivers would indicate where their inflation forecast should be next year. From that point of view, the strength we've seen in the Rand between the meetings, should imply some moderation or at least hold, in the inflation forecast for 2015.
ALEC HOGG: It sounds as though the two of you have been swopping notes, Izak.
IZAK ODENDAAL: I actually didn't get the audio on that, but I suspect she'll agree. Most economists at this stage think that there won't be a rate hike tomorrow. The reality is the Reserve Bank doesn't want to hike. This is not an environment – with very weak growth and with rising unemployment – that you want to be hiking. They hiked in January because they were forced during that whole Fragile Five mini-crisis, to follow our peer countries in the emerging markets, but it's not an environment where you want to be hiking.
ALEC HOGG: That's an interesting insight because sometimes the bureaucrats can go ahead and do things without really looking at the way the environment is outside of their offices. In this case, the Reserve Bank has a very big remit. They have to be pretty sure that the economy can sustain, or isn't damaged by another interest rate increase.
IZAK ODENDAAL: Yes. Their mandate is to keep inflation between three and six percent, but it is a flexible mandate, so they need to take into factors such as unemployment and economic growth etcetera into consideration. They have been quite flexible, they have been quite pragmatic about the approach to monetary policy, and I think you have to commend them for that. It helps of course, as I said that the whole emerging market scenario looks a lot better now. We've seen quite generous capital flows back into the economy or back into our bond and equity markets over the last two to three months, unlike in January when they hiked. The Rand has stabilised and strengthened a bit, so the global environment has also helped them in that regard. Of course, Global Central Banks in the developed world are committed to keeping interest rates low. Tapering or no, interest rates remain low.
ALEC HOGG: That was Izak Odendaal, Investment Strategist at Old Mutual Wealth. Thanks, Izak. That was very well put and nicely summarised. It doesn't look like interest rates will be ratcheted up a little more tomorrow. Of course, we never do know, but that's what the environment is suggesting to us.