ANYONE who was following Reserve Bank governor Tito Mboweni's utterances in the first half of last year had to pinch themselves on Tuesday. The governor is, for the first time, distinguishing between cost-push and demand-pull influences on inflation.
Mboweni on Tuesday cut the repo rate by one percentage point to 9.5% as expected and released a statement which implicitly made it clear that there are different kinds of pressure on inflation.
To those not familiar with the economic jargon, demand-pull inflation refers to inflation that is caused by excessive consumer spending, usually on credit.
This is the situation that develops when there is "too much money chasing too few goods" and prices rise because demand outstrips the supply.
In this case, interest rate increases are the right ammunition to fight inflation, because they dampen demand.
Cost-push inflation, on the other hand, refers to shocks such as a surge in the oil price - which obviously has nothing to do with domestic consumer demand. It concerns prices set on global markets over which the central bank has no control. Food prices are another example.
It's clear that when it comes to cost-push inflation, interest rates are a less effective weapon. More importantly, interest rates increases can lead to a situation in which the medicine is so strong that it kills the patient.
Obviously, this is a very superficial explanation and inflation is a more complex phenomenon than I have described. But the crucial point is that Mboweni last year - when commodities prices were soaring and Eskom threatened a 53% tariff increase - refused to listen to arguments that one should distinguish between the two kinds of inflation.
The point then was that his interest rate action had already done enough to curb demand.
On Tuesday, Mboweni changed his tune. In the monetary policy committee (MPC) statement's section on the outlook for inflation, he said: "The upside risks to the inflation outlook emanate primarily from cost-push pressures, particularly from administered prices. These include possible higher-than-expected electricity tariff increases.
"The decline in inflation may also be delayed by continued high rates of increases in food prices, despite marked declines in producer price food inflation."
Hollow ring
Though this is a victory for Mboweni's 2008 critics, the victory has a hollow ring. The fact is that, though interest rates had to rise since June 2006, they didn't have to go up to the extent that they did - five percentage points between June 2006 and June 2008.
If Mboweni had been able to distinguish between cost-push and demand-pull inflation in 2008, the increases would have been more moderate - and some of the damage to the economy could have been avoided.
Mboweni went out of his way on Tuesday to blame the global economy for the weak state of the SA economy. But the fact is that his actions bear a big part of the blame for the decline in gross domestic product (GDP) suffered in the last quarter of last year, and the only marginal growth recorded in the third quarter.
The GDP breakdown shows that the retail sector, which accounts for 14% of the economy, has been recording negative growth for three quarters.
Mboweni himself highlighted the slowdown in domestic demand in the MPC statement. Quoting the latest figures, he said consumption expenditure by households declined 2.7% in the fourth quarter of 2008, mainly as a result of a 20% contraction in consumption of durable goods.
"Domestic demand conditions are expected to remain under pressure as a result of declining disposable incomes, tighter credit conditions and negative wealth effects," the statement said.
And now?
The question now is whether Mboweni is going to push the pendulum too far to the other side.
Having erred in the upward cycle, is he going to cut rates too much in the downward one? That's what happened in the previous downward cycle, which helped create the conditions for the boom and bust we've experienced.
It seems those hoping for massive further interest rate cuts will be disappointed. During the press conference, Mboweni warned people against reading too much into the increased frequency of MPC meetings.
He said people shouldn't think that "this year there will be so many reductions. Anybody who takes that position is a fool".
Still, more reductions are on the way, though not as many as some would have hoped. Ideally, Tuesday's cut should be followed by another full percentage point reduction in April.
After that, it's time to slow the pace, to 0.5 percentage points in June and August each (there's no MPC meeting in July).
- Fin24.com