Inflation panic drives MPC to increase repo rate by 25 basis points

The Monetary Policy Committee (MPC) has increased the repo rate by 25 basis points, on the back of panic about inflation, although economists were expecting it to remain the same for the eighth time.

While the MPC expects inflation to stay close to the mid-point over the forecast period, inflation risks have increased and the level of policy accommodation remains high.

Reserve Bank governor, Lesetja Kganyago, said in his announcement that the average surveyed expectations of future inflation remain at 4.2% for 2021 and 4.4% for 2022, with market-based surveyed expectations for inflation for 2021 broadly unchanged.

Against this backdrop, the MPC decided to increase the repurchase rate by 25 basis points to 3.75% per year, with effect from tomorrow. Three members of the MPC preferred an increase and two members preferred an unchanged stance.

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What economists say

Prof. Jannie Rossouw from the Wits Business School says he really expected the first increase early next year and wonders if the MPC is not aiming at an inflation target of 3% instead of the current 4.5%.

“We must also remember that although people will pay more for credit, it also means that people who save will get higher interest.”

Economist Mike Schűssler says it was a close call and the MPC were between a rock and a hard place.

“This increase will not be as painful for consumers as the massive hike in the petrol price. It is also possible that the MPC decided on the increase to prevent consumers from spending too much on Black Friday and the festive season,” said Schussler.

Virus remains a risk

Kganyago said steady advances in vaccination rates have sustained confidence and the global economic recovery this year, but recoveries in emerging market and developing economies will continue to lag those in advanced economies, mainly due to slower vaccinations.

“However, the virus remains one of a series of current risks to South Africa’s economic growth outlook that includes rising inflation, weaker commodity export prices, stagnant investment and the longer-term impact of scarring from the pandemic and the July unrest.”

ALSO READ: Reserve Bank raises repo rate to 3.75% after power cuts dim SA economy

Gross domestic product

The forecast of the International Monetary Fund (IMF) for global gross domestic product (GDP) is 5.9% in 2021, slowing to 4.9% in 2022 while the Reserve Bank’s forecast for global growth in 2021 is 6.3%, up from 6.2% and unchanged at 4,4% for 2022 and 3.3% for 2023.

Kganyago said while the domestic economy grew strongly in the first half of 2021, mixed results are expected in the second half of the year. “Overall, we forecast the economy to grow by 5.2% this year (from 5.3%), revised down due to the larger negative effect on output than was previously estimated from the July unrest and other factors.”

He said the revised estimate for third quarter economic growth is -2.5%, compared to the previous 1.2%. A GDP outcome of 2.6%, compared to the previous 1.6% is expected for the fourth quarter. However, despite these quarterly revisions, the annual growth rate in GDP for 2021 reflects a healthy bounce back from the economic effects of the pandemic.

Economic growth expectations

Economic growth is expected to align with a low rate of potential growth over the next two years, with GDP expected to grow by 1.7% in 2022 and 1.8% in 2023, unchanged from the September forecast. GDP growth in 2024 is forecast to be 2.0%.

The July unrest, pandemic and ongoing energy supply constraints are likely to have lasting effects on investor confidence and job creation. High export prices are also expected to fade and weak job creation will moderate household consumption. Therefore, the risks to the medium-term domestic growth outlook are assessed to be to the downside.

While the current account surplus remains substantial, it is expected to be significantly smaller than the September projection, at 3.8% of GDP in 2021 (from 4.6%). Prices for important commodity exports such as rhodium, iron ore, coal and platinum have decreased in recent months, while oil prices have increased by about 68% year to date.

Higher prices and stronger demand for imported consumer and investment goods and the commodity and oil price movements imply a smaller trade surplus changed the expectation of a current account surplus of 0.7% of GDP for 2022 to a current account deficit of 0.6% of GDP.

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Exchange rate

Kganyago also did not have good news about the rand, saying that while generally favourable global financial and economic conditions and strong commodity export prices strengthened it for most of the year the currency above its long-run equilibrium level, increased uncertainty about global inflation and policy settings, with a moderation in the terms of trade, contributed to a weaker rand exchange rate.

The rand has depreciated by about 5.9% against the US dollar since September and is now below its equilibrium level. The implied starting point for the rand forecast is R15.1 to the US dollar, compared to R14.47 at the time of the previous meeting.

Inflation

The Reserve Bank (Sarb) forecasts higher headline inflation for the fourth quarter at 5.3% and expects it to increase to 4.3% next year and 4.6% in 2023, with headline CPI of 4.5% for 2024.

“Given the expected trajectory for headline inflation and upside risks, the MPC believes a gradual rise in the repo rate will be sufficient to keep inflation expectations well anchored and moderate the future path of interest rates.

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Future expectations for repo rate

“Economic and financial conditions are expected to remain more volatile for the near future. In this uncertain environment, policy decisions will continue to be data dependent and sensitive to the balance of risks to the outlook. The MPC will seek to look through temporary price shocks and focus on second round effects,” Kganyago said.

He said better anchored expectations of future inflation should keep interest rates lower for longer and can be realised by achieving a prudent public debt level, increasing the supply of energy, moderating administered price inflation and keeping wage growth in line with productivity gains that will enhance the effectiveness of monetary policy and its transmission to the broader economy.

“However, the virus remains one of a series of current risks to South Africa’s economic growth outlook that includes rising inflation, weaker commodity export prices, stagnant investment and the longer-term impact of scarring from the pandemic and the July unrest.”