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MONETARY POLICY OUTLOOK

01/02/2023 14:07:00 Sanele Sibiya

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The South African Reserve Bank raised its benchmark repo rate by 25 basis percentage points (bps) to 7.25 per cent at its January 2023 meeting, while markets had expected a 50 bps increase.

The Central Bank of Eswatini (CBE) followed suit and raised interest rates from 6.5 per cent to 6.75 per cent, signaling a 25 bps. This marks the eighth consecutive rate hike since policy normalistion started in November 2021, to anchor inflation expectations more firmly around the mid-point of the target band of 3-6 per cent and achieve the inflation target in 2024.
Indications are such that we shall begin to see a slowdown in the aggressive stance by the CBE, however, the upward trajectory is likely to remain since inflationary outlook remains risky; the current aggressive moves are likely to take effect in 2024 and rein in inflation back to the confidence band of six per cent. Domestically, according to the MPC statement, headline inflation decreased from 5.8 per cent to 5.6 per cent in December 2022, compared to previous months. One might then ask the question, why are we not forecasting an interest rate decrease in the domestic economy, as we seem to be getting the fundamentals in place and is it not time to let the economy breath?

Is it not time to let economy breath?

The current inflation pressures and risks indicate that we are contending with supply side risks to inflation. As stated in numerous thoughts before, the actions of the central bank are what economists term ‘demand side policies’. Basically these policies are designed to alter final demand in the economy and push the economy back to equilibrium. Economic policy as we know it or the current economic dispensation adopted by the country is not capable of affecting supply side dimensions. The current wave of inflation pressures is influenced by the COVID-19 pandemic and disruptions to supply chains, the war in Ukraine and the disruptions to the global oil supply, and the global grain market. The sanctions on Russian oil and other products negatively impacted global oil prices, the world was not ready for the extent to which the west was willing to hurt itself to prove to Russia that the invasion of a sovereign territory will not go unpunished. Hence, until the supply chains are restored, that is, will China abandon her zero COVID-19 strategy? Or will the world establish a new global supply factory outside of China.

Will the world establish a new supply for the global grain coming out of Ukraine, which supplied 13 per cent of global wheat output? Will the world be able to induce OPEC to increase global oil output to ease pressure further down at the pumps? The most important question is what impact does an interest rate increase or decrease have on these major fundamentals? Does an increase in the interest rate curtail Russia from bombing Ukraine? Does it get China to abandon the zero COVID-19 strategy? The answer is a big no, and we beg to answer the question; why then are the rates increasing, and why are they still expected to increase albeit in a slower rate?

Interest rate increases

Economic indicators show that we are not likely to see decreases in the interest rate anytime soon; most likely expect a decrease in the last quarter of 2023 if we are lucky. The most plausible time for a rate decrease is the first quarter of 2024; precisely because we are dealing with a supply side problem and the CBE is doing its best to minimise the impacts of the supply side shock on the economy. The actions of the CBE are but precautionary to ensure that inflation does not spiral out of control, while the fiscal and political arms of the global economy mediate a solution to the current inflation problem. Furthermore, until inflation in South Africa is reined in to the confidence band of 3 - 6 per cent, the CBE will have very little room to maneuver a rate decrease.

This is because the monetary policy within the Common Monetary Area (CMA), a monetary policy union between South Africa, Eswatini, Lesotho and Namibia, has to be in unison. The one-to-one peg between the Rand and Lilangeni is sustained by a no interest differential between the member countries, ensuring that capital does not fly from one destination to the next.
We can only have a small interest rate differential between the two countries, but nothing major. Although the fundamentals are in order domestically, until we have reached unison within the CMA, we will have to suffer the interest rate hikes as a unit. Furthermore, we are a net importing nation, it would be very easy for us as a country to import inflation from abroad as such the precautionary moves by the CBE will still be maintained.

Survival

At a micro-level, to survive the hikes we need to make sure to borrow responsibly so that we limit our overall exposure to the interest hikes. The advice is to ensure that you have a cushion of approximately E8 000 to absorb interest rate hikes, and be able to live with it. Also, it is imperative we adopt a thrift lifestyle in these trying times.