Cape Town - Is the monetary policy committee (MPC) - and in particular Reserve Bank governor Gill Marcus - a 60/40% or a 40/60% inflation vs growth targeter? The real test of this has now begun, said Nomura economist Peter Attard Montalto.
Until now inflation has been low enough with more balanced risks to allow targeting of and cutting on growth. The balancing act now is at a critical juncture, however, and the true nature of the MPC and the governor will be revealed in the coming meetings, he said.
The MPC left rates unchanged at 5.00% on Thursday.
According to Montalto, the broad balance of the statement remained on the dovish side of neutral. "The CPI (consumer price index) outlook was seen higher, growth lower, risks to CPI skewed more to the upside, and those to growth more to the downside vs those new forecasts.
"Crucially, we think the MPC is now being much more realistic about inflation next year and its forecasts are now in line with ours, though it keeps long-run inflation for 2014 unchanged which is more bullish than our view of a target breach through end 2014.
"This anchoring is important for considering the rates outlook."
Inflation risks remained from the currency, administered prices and food, according to the MPC, though it highlighted the much faster pass-through of forex weakness to food.
According to Montalto there was a substantial and important part of the statement that was not directly relevant to the rate decision, where the MPC pleaded with workers to stop violence and understand the constraints of company balance sheets and of competitiveness.
"We think that was a quasi-political call ahead of the Mangaung elective conference, but also to give a warning shot across the bows of the populace that even if there were some room for adjustment by the MPC, it could not solve these more structural issues."
No discussion of an interest rate cut, unlike at the last meeting, raises the question of why rates were not cut with growth forecasts lower, yet even with inflation forecasts revised higher it is still seen as being in target, Montalto argued.
"The statement says that the current accommodative stance 'remained appropriate' given the balance of risks. However, we think there are a few key reasons why there was no cut:
- The cut that took place in July is key. That basically was on growth risks and those growth risks have now materialised into the forecast. Hence, there was no need to cut on the growth forecast revision (even presuming the MPC puts a high weight on growth over inflation).
- Real rates are always important and have under-ridden previous cuts. With the shift up in CPI forecasts for this year and next, a natural loosening was expected in real rates while overall monetary conditions would have been looser thanks to the weaker rand. As such, again there was no need to cut.
- Upside inflation risks, while from non-core in the MPC’s view are much more immediate than the slightly longer gestation period for growth risks to materialise.
"This last point is important and feeds into our outlook. We think the Sarb (SA Reserve Bank) needs additional shocks to growth and the realisation of the current additional downside risks to growth in its forecast in order to cut again. They could happen by Q1 (or it may not), but now was not the right time.
"All this still fits into the rhetoric we heard from MPC members in recent interactions – their view of there still being room to cut but with a highly uncertain outcome of risks that must be realised into real shocks is still in place despite no cut today (Thursday)."
The key test, according to Montalto, will be whether the MPC can cut rates when these risks come through and presuming core CPI is still under control.
"Will such a cut be dependent on headline CPI or the rand?
"At the end of the day it will balance around the size of the shocks to come and here the downside risks from the US fiscal cliff and Asia hard landing (which were not mentioned today, in contrast with previous meetings) are important and factors on which we think the MPC may be overly bearish.
"If those shocks to growth are big enough then we think the MPC could cut with CPI outside of target (just) on non-core pressures, or equally with ZAR a bit weaker still from here. However, if those shocks are smaller than the Sarb expects, we think there will be no cut."
The announcement on Thursday gave more prominence to the rand, but there was also an acceptance that the MPC does expect overshooting to occur in currency moves, said Montalto.
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