THE Reserve Bank expects the upper limit of its inflation target to be breached in the first quarter of next year. In theory, it should have hiked interest rates already, because there's a lag between interest rate movements and their effect on the economy.
However, the bank takes a host of factors into account other than a simple breaching of its target. The questions are: how sustainable is the breach? Has it been caused by cost-push (outside) factors or demand-pull factors? How weak or strong is the economy generally? What does the international environment look like, including the rand?
All these questions can be expected to be addressed in this week's monetary policy committee (MPC) statement.
At this point the Reserve Bank doesn't expect a sustainable breach of 6%; it expects the inflation rate to go below target again by the second quarter of 2012 and to remain close to the upper limit of the target range for the rest of that year.
But that's sailing close to the wind. Still, as the bank pointed out in its last monetary policy statement, the "underlying inflation pressures are mainly of a cost push nature. These developments are expected to result in a temporary breach of the upper limit of the target band during the first quarter of 2012.
"It is recognised that these pressures have the real potential to generate second-round effects which can result in more generalised inflation."
As long as the inflationary pressures are cost-push in nature – that is, resulting from food, oil and electricity price shocks – the bank won't act. There is little sign yet of inflation excluding food, petrol and energy getting out of hand. This measure of inflation has reached 3.2% from a low of 3% in January to March.
However, the bank can't wait for this inflation to take hold before acting. It has to keep its eye on other indicators of demand that will tell it whether there's a danger of more generalised inflation. One such indicator is retail spending. Here, the signs of demand are strong.
The annual growth rate in retail spending rose to 9.8% in April from 5.3% in March, well above the consensus forecast of 5.1%. But sales may have been boosted by the large number of public holidays in April, which gave consumers more time to spend.
The first-quarter consumption spending figures for households have also been released since the last MPC meeting. Consumption spending differs from retail spending data in that it includes services and motor vehicles. This spending was up 5.2% in the first quarter (quarter-on-quarter, seasonally adjusted and annualised). It's a robust growth rate.
Consumer spending is the main engine of economic growth. How does the Reserve Bank decide whether spending is simply robust, or too strong? One way to do so is to look at indebtedness; at nearly 77% of disposable income, consumers are still highly indebted and unlikely to splurge. Strikes and global troubles play their part
This has been clear from the credit figures, where the upswing in household credit growth has been tepid. Nedbank Group [JSE:NED]
says in a note to clients: "High existing debt levels, tighter lending standards, rising cost pressures from higher food and fuel prices and growing speculation of possible interest rate hikes later this year will contain the pace of (household credit) recovery compared with the previous credit cycle."
The Reserve Bank would also have taken note of the fact that corporate demand for credit is very weak. If corporate SA had more confidence in the domestic economy, this wouldn't be the case. A fall in corporate credit led to the growth rate for private sector credit extension falling unexpectedly to 5.2% in May from 6.2% in April. This indicates weakness in the economy.
A major source of concern about the health of the economy comes from manufacturing production, which had been the main driver of the first quarter's solid 4.8% economic growth rate. Growth in manufacturing production remained weak in May after a sharp slowdown in April.
Year-on-year growth rose to only 0.6% in May from a revised 0.2% in April and against the market consensus of a rise of 2.4%. Added to this is the current wave of strike action, which will also hit economic growth.
This, together with the soft patch in the global economy, will give the Reserve Bank reason not to hike interest rates. The US unemployment rate rose, while that country's latest industrial production and retail sales remained lacklustre.
The eurozone debt crisis doesn't want to go away, while China is trying to engineer a soft landing for an inflation-ridden economy. The global picture also doesn't look good for domestic economic growth - another reason for the Reserve Bank to hold fire.
Fewer economists now expect the Reserve Bank to raise rates in September, particularly after the bad manufacturing output number. Even November looks in doubt now. The bank will probably wait until the first quarter of next year before raising rates, barring a full-blown crisis in Europe.
The bank will want to raise rates when inflation is near the ceiling, to send a message to the public that it's not sitting on its hands and to ensure that a temporary breach doesn't become prolonged.