MPC repo rate misfire

Economists are known to be diplomatic when reacting to economic developments involving the state and the South African Reserve Bank (Sarb).

At some companies, especially banks, policies often prevent economists from commenting on the likely impact of political events on the economy or criticising these regulators.

The reasoning behind these policies is clear: avoid alienating vital stakeholders, as doing so could jeopardise future engagements or negotiations. The underlying argument might be summarised as: “A sound bite in the media is not worth a billion-rand’s worth of business.”

This cautious approach was evident on Thursday when Reserve Bank Governor Lesetja Kganyago announced a modest repo rate cut of just 25 basis points (bps).

ALSO READ: Repo rate cut too small to help SA consumers who cannot afford food

This decision was a little unexpected given that inflation had fallen to 2.8% in October – well below the lower boundary of the Reserve Bank’s 3%-6% target range. The last time inflation was this low was in May 2020, at 2.1%.

Looking even further back, inflation hasn’t been lower than 2.8% since 2005 – nearly two decades ago.

To provide context, the recent repo rate hiking cycle began in November 2021. During that period, the Reserve Bank’s Monetary Policy Committee (MPC) raised rates ten times in 18 months, with the repo rate peaking at 8.25% and the prime lending rate of commercial banks at 11.75% in May 2023. This was in response to inflation rising from 5.5% to 7.8%.

Since May 2023, inflation has dropped significantly to its current level of 2.8%, yet this has resulted in only two 25 basis point cuts. This overly cautious approach raises questions about the MPC’s strategy.

ALSO READ: Reasons for repo rate cut of only 25 bps not convincing – economist

What is particularly surprising is that the MPC did not even discuss a 50-basis point cut, as Kganyago revealed during the press conference.

With inflation near its lowest level in two decades, why was a more substantial cut not considered? It is perplexing, especially given Kganyago’s firm denial that the MPC has set an unofficial inflation target closer to 3%, rather than the legislated 3%-6% range.

While we may never know the full rationale, to quote the late Pravin Gordhan: “Connect the dots…”

Following the announcement, I discussed my concerns with two well-known economists from leading financial institutions. Privately, they strongly criticised the MPC’s decision. Yet, in subsequent media coverage, the harshest public critique was that the decision was “surprisingly hawkish”.

ALSO READ: Reserve Bank cuts repo rate by only 25 bps despite economists’ call for 50

This cautious public stance underscores how institutional policies influence economists’ willingness to speak freely on such matters.

Another possible explanation is that the MPC is out of touch with the realities of the South African economy.

Consider the impact of high interest rates on households. For example, a household with a R500 000 home bond repaid over 20 years at the prime interest rate would have paid R3 876 per month in 2021. Granted rates were slashed at the time due to the Covid-19 economic fallout.

After the recent cut, that monthly payment has increased to R5 246 – a staggering 35% or R1 370 more. While the 7% prime rate seen in 2020 might be an outlier, it illustrates how sharply rising rates have drained disposable income from consumers.

Economic growth is desperately needed to address South Africa’s severe challenges. An interest rate cut alone is no silver bullet, but it could serve as a small spark to ignite recovery.

The decision to limit the rate cut to 25bps without even entertaining a more significant reduction reflects an overly conservative stance that risks stifling growth. The MPC misfired on this one, I’m afraid.

This article was republished from Moneyweb. Read the original here.