GILL Marcus' real test as Reserve Bank governor awaits. So far, she's had the easy part – cutting rates and doing nothing. She should do nothing for a while still, but the question is: for how long? When should rates be raised and how should the market be prepared?
With the repo rate at 5.5% and anticipated inflation at 5.5%, there can be no doubt that monetary policy is extremely loose. That's the conclusion from the fact that the real repo rate is zero. But policy was loosened in response to an economic crisis.
It's fair to assume that policy won't be tightened as long as the lingering effects of the crisis are felt. Some would argue, as does trade federation Cosatu, that the unemployment situation puts the country into something of a permanent crisis, and that policy should be loosened further.
But the Reserve Bank has a mandate: it has to set policy to keep inflation between 3% to 6%. True, it can be flexible so as not to kill the economy in an effort to meet the target. But there comes a point when flexibility translates into a loss of credibility.
That's something the bank will want to avoid. After all, Marcus herself has repeatedly stated that the main aim of the central bank is to fight inflation. It does this with a view to ensuring sustainable growth, because inflation will erode the benefits of an excessively loose monetary policy for the economy.
Inflation seems to be back on the rise again, albeit slowly. The consumer price index (CPI) was up 3.7% year-on-year in January, and is forecast to stay at that level or tick up to 3.8% when February figures are released on Wednesday.
SA isn't yet in the situation of other emerging markets - as well as Britain and the eurozone - where inflation has already reached worrying levels.
But it's not today's inflation that's the issue; it's future inflation. The actions the bank takes now only takes effect on the economy six months to a year or even longer down the line. The bank has to act with its eye on the future, both with regard to inflation and economic growth.
Most economists now see inflation near 6% by the end of the year, and some see it reaching 6% early next year. In theory then, the bank should already be hiking rates. But that would be overkill, especially if inflation is expected to stabilise at around 6% and not to shoot into the stratosphere.
Baby steps will be bestSome may ask why hike at all if inflation settles around the 6% level for a while? Why not use the flexibility allowed to the Reserve Bank to let the economic recovery gain momentum? This question is especially relevant as food and fuel prices – exogenous shocks – will be the main factors driving inflation, and not demand.
The reason has to do with inflationary expectations and strength in the economy. If people see the Reserve Bank does nothing when inflation is at or near 6%, they will find it easier to fund a credit-fuelled boom.
That boom will see prices rising rapidly as retailers' pricing power increases, lifting inflation further. Also, if inflation is at or near 6% while the economy is growing near its potential of about 4%, it means there will be less slack in the economy which will put pressure on inflation.
So, it's clear that the Reserve Bank should hike when inflation nears 6% and when the economy is at or near its potential. Many economists believe this will be in the final quarter of this year.
Brait economist Colen Garrow points out that the forward rate agreement market has priced in a better-than-even chance that the repo rate will be raised by 100 basis points in the final quarter of this year. It would make sense for the Reserve Bank to do that, rather than wait until early next year.
But the hike in rates should be slow and small – the economy can't afford big shocks. The highest that the bank should go is three percentage points over two years. That would reverse interest rates from the crisis levels prevailing at the moment without providing a big shock.
The household consumption expenditure figures that came out on Monday, showing a slowdown in the quarter-on-quarter and annualised growth rate in the fourth quarter to 5.1% from 5.7%, suggest that an earlier rate cut – the third quarter – wouldn't be appropriate. Citigroup expects the first rate hike to be in September.
The bank should start preparing the markets for the timing of the first interest rate hike from this week's monetary policy committee meeting. The big question is whether the first hikes will come in the fourth quarter of this year or early next year.
The bank should prepare the market if it's going to postpone the rate hike to the first quarter of next year.
- Fin24