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Cees Bruggemans: MPC’s rate hike gun loaded and willing

By Cees Bruggemans

The South African Reserve Bank (Sarb) kept rates unchanged, prime staying at 9.25%. But two out of six members voted for a 0.25% increase. The Sarb statement from the MPC concluded that the deteriorating inflation outlook suggests that this unchanged stance CANNOT be maintained indefinitely.

Okay, so raise when by how much? They left that hanging in the air…. Explicit policy forecasts not being their strong suit, preferring to be “data dependent” when acting. Who can blame them?

The analysis offered was grim, and came in installments.

As a FIRST offering, Sarb expects headline CPI inflation to “breach temporarily” the upper end of the 3%-6% target by early 2016 and to stick “uncomfortably close” to the upper target through 2017.

Headline CPI inflation forecast

4.9% average 2015

6.8% peak 1Q2016

6% by 2Q2016

6.1% average 2016

5.7% average 2017

This first estimate assumes Eskom increase of 13% in July 2015. It does not as yet incorporate the extra 12.6% increase requested (to be decided by end-June).

Core CPI (excl energy & food)

2015         5.6%

2016         5.4%

2017         5.2%

This core inflation persistence at elevated levels is a function of high wage growth, Rand decline & entrenched inflation expectations near target end.

As a SECOND offering, Sarb then says that if Nersa fully accedes to the Eskom request, the CPI peak will be over 7% and the breach more extended, average CPI inflation being 0.5% higher per year.

You can hear the MPC’s  loaded gun being primed & cocked, ready to fire.

One can also imagine Nersa being invited to think very carefully before acceding to the additional Eskom request. It may have major consequences, greatly adding to the economic cost of such a decision. It should not be taken lightly, or in ignorance of such consequences. It is the Sarb’s understated way of making its presence known.

Hello guys, you haven’t forgotten about us, have you?

According to Sarb, inflation risks come from four major sources.

Firstly, primarily, due to further possible additional Eskom electricity tariff increases (meaning the extra 12.6% or even more?).

Secondly, a weakening Rand due to uncertainty about impending US monetary policy. Sarb acknowledges that Rand pass-through to inflation remains half from what modeled (expected). But this comes across as a source of anxiety rather than happiness. Can’t believe our luck will hold, can they?

Thirdly, wage growth is a concern. Average wage/salary growth is higher than inflation, offering automatic indexation of wage settlements, maintaining mid-single digit inflation, with unit labour cost growth of 6%.

There is of course nothing new about these tendencies these past 10 years (or past 50…..) but it is nonetheless offered with a sense of distaste, as if this should not be. Fair enough. But what to do about it remains safely in abeyance.

Instead, upside risks to inflation from wage pressures and unresolved settlements in coal & gold are noted as a concern.

Fourthly, food prices are a concern due to drought conditions & weak Rand, with maize prices rising to import parity levels.

Thus Sarb notes persistence of high medium-term inflation and deteriorating risks to outlook an increasing concern.

It concedes (on a first reading) that any breach (of 6% inflation) is expected to be temporary BUT (on a second reading) notes that the long-term trajectory is close to the upper target end, with (many major) upside risks making the trajectory vulnerable.

Sarb powerfully concludes that the main upside inflation risks are firstly electricity (the extra Eskom bite), secondly the Rand (Fed-driven), and thirdly wage settlements (potentially triggering a wage/price spiral).

Thus Sarb is prepared to put on display the worst of its realism.

The MPC acknowledges that it should look through supply side shocks such as oil & electricity BUT there always lies in wait second-round effects on inflation expectations. These cannot be left to their own demise…..

It is true the economy, especially demand, is weak, with electricity constraining output growth, consumer & business confidence. Such growth downside CANNOT be solved by monetary policy alone. Sarb would be amiss if not paying adequate attention to inflation risks, if in an nuanced way. And thus the heavy emphasis on the inflation leg where Sarb may make a difference in influencing expectations.

And that is what we got this Monetary Policy Meeting: a loaded and primed gun, cocked & ready to fire. Make My Day & all that. Which it clearly will, some time later this year when flaring SA inflation and Fed liftoff finally combine to put again enough pressure on use to release the trigger.

Bang bang. I shoot you down. Bang bang….

* Cees Bruggemans is an independent consulting economist; access more of his work on his website at: www.bruggemans.co.za

* For more in-depth business news, visit biznews.com or simply sign up for the daily newsletter.

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