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Johannesburg - The SA Reserve Bank (Sarb) last month was severe and hawkish enough to make it sink in that the bar is set very high for any interest rate cuts this year. Instead, it was allowed that this country needs more reform rather than more monetary accommodation.
In any case, Sarb is yet to fully buy into various propositions, such as that oil prices are being durably lowered, that our inflation rate will move sustainably lower rather than merely blipping, that sticky wage growth will be lowered rather than doggedly persisting, that inflation expectations will also decline.
Besides, the real trade-weighted rand has fallen for four years, only by late last year showing evidence of stabilising anew, but no longer overvalued and now modestly undervalued. SA isn’t necessarily looking for more rand weakness if it can help it, indeed fearing it most for its many destabilising influences on our inflation and wage demands. The main reason for finding the Sarb so hawkish.
A bit of trade-weighted recovery might not be unwelcome to Sarb, assisting inflation repression and market credibility.
The list of countries cutting rates is growing, Aussie being the latest to cut by 0.25% to a record 2.25% low, citing weak growth and subdued inflation, setting in motion expectations of at least two more such rate cuts to come. China taking easing measures, and this also widespread in Eastern Europe.
For many of the global rate cutters, starting with the big players, Japan and Europe, one of the unspoken consequences would be a lower, more competitive currency, in a growth-underperforming world in which inflation this year will fall yet further.
Countries are apparently getting desperate, to address their falling inflation rates (in many cases too low) and protect the little growth momentum they may have.
The cutting of interest rates lowers returns, with currency weakness resulting. It is a desired outcome under present circumstances.
Not for the Sarb, as already indicated. But how long before it might show similar tendencies? Matching that high bar of preset conditions? Especially if the trade-weighted rand starts firming because of the global yield search & hawkish Sarb stance, if going to far just as much unwanted as another sizeable rand decline?
Even so, Sarb retains dread of what is likely to happen once the Fed starts raising its interest rates from later this year. This is not unwarranted, given the highly volatile nature of market expectations, the one week blowing cold about American growth and rate prospects, the next week blowing hot, this abrupt change again noticeable last Friday on non-farm payrolls being solid, and our risks coming more fully back into focus.
Our fragile state, reflected in our large current account and budget deficits, makes us a sitting duck for more discerning capital flows more cautiously differentiating between more risky country propositions.
In this line of reasoning, more financial market instability globally later this year may give us more rand weakness than what we know what to do with, boosting our inflation anew, and intensifying our structural imbalances rather than provide assistance in erasing them.
Yet on all these fronts Sarb runs the risk of finding its flanks turned as the year slowly unfolds, especially if it stays hawkish in an ocean of global peer doves.
Yes, the Fed may start tightening interest rates eventually, but likely will proceed very slowly, even as Europe and Japan continue with large unconventional bond purchases. That may keep global markets more lively, and yield seeking more determined, preventing as much of an onslaught on our fragile state than feared.
Also, oil and energy prices generally may remain relatively low for longer, and with it the lowered headline inflation effect, in turn eroding core inflation and wage bill inflation more than envisaged.
Our growth is unlikely to surprise too much to the upside during 2015-2016, but our inflation trajectory may surprise to the downside, not only because of oil first round effect but also because of resulting second-round effects. Also, the trade-weighted r
and may be supported enough by weakening non-Dollar currencies (and our so-called “hawkish” inclination to keep our rates on hold for longer) to neutralise at least partially some of the strengthening Dollar effects.
In which case we too might experience an Aussie moment, only much later in 2015, and be recognised as a latecomer rate-cutter that wanted proof positive first that it was safe to act, with our perceived fragile status and all that surrounds it preventing first mover status.
Sarb sees enough reason to doubt the benefit of rate cuts at this early stage, preferring to be seen on hold, on balance more inclined to see the world coming around to its view, at which point it will be time to resume the tightening cycle, the old trajectory whose reasoning remains very much with us.
Others overseas either face fewer constraints than we do, true of many central banks recently cutting rates, or have deliberate outcomes in mind, in which more competitive currencies and a boost for inflation expectations could be some of them.
For such central banks it is relatively easy cutting rates now. Our Sarb faces a much more challenging structural reality, certainly at home, and its world view probably is still so geared, too, when it comes to distilling Fed threats to our well-being once its policy stance starts to shift.
And market volatility from the one week to the next certainly contains a strong hint that Sarb is not misguided on this score.
To summarize, there are three dimensions to the Sarb’s reasoning setting a high bar for any rate cutting this year or next. It seems all to turn on what Sarb believes (accepts), disbelieves (questions) and dreads (fears).
Sarb accepts we are fragile, going by our big current account and government deficits. Discerning capital flows could disturb the rand, lift inflation. Not a risk worth running. Growth-wise, the country needs more reform rather than more easy money.
Sarb appears to question that the oil price plunge will have legs, that inflation decline this year will persist, both ere long possibly popping back up. Most of all, it seems to think our wage/salary trends are sticky, unlikely to ease and to lead to lower inflation expectations. In which case why bother with rate cuts if you have to raise ere long with the Americans (the dollar and the rand) centrally in mind?
Also, Sarb has a healthy respect for the Fed’s traditional ability to be a disturber. When the Fed starts raising US interest rates, with the Dollar rising steadily, this tends to disturb global markets. That is when too low SA interest rates may be regretted if it leads to a run on the rand and pop-up in our inflation needing higher rates.
Instead of running all these (high) risks, Sarb prefers to take a wait-and-see attitude, one of show me the evidence that it is safe to cut rates and not to get penalized before long.
For that reason it appears willing to outwait events, not join the many countries now cutting, because it knows from past experience that market trends can change tack quickly, and it doesn’t want to get caught with SA rates too low, if that were to happen.
Thus the Sarb’s rather severe, even hawkish attitude, going on hold with rate jacking, but not willing to cut rates until it has made absolutely sure it is safe and the right thing to do. Its body language says it doesn’t expect that to happen. And thus we are on hold, and likely to remain on hold for the time being, with prime stuck at 9.25%.
The flip side is that it could mean a firmer rand for a while than discounted by many. So be it? Market volatility will probably ensure it won’t get too far out of line.
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