I WAS surprised to read a comment from a banker last week, saying that the rand was strengthening in response to Reserve Bank governor Gill Marcus' "hawkish" comments which suggested interest rates would rise sooner rather than later.
The opposite is true. If the Reserve Bank can help it, interest rates won't rise before late this year or early next year. That's my reading of the monetary policy committee (MPC) statement, which took a highly objective view of the economy, but nonetheless can be interpreted as coming down on the side of later rate rises.
Marcus made a very important distinction in the statement. She distinguished between cost-push and demand-pull inflation. Cost-push inflation is caused by supply shocks such as the oil and food price shocks.
It's the result of factors exogenous to the economy, and has nothing to do with consumer demand. Demand-pull inflation results from strong demand in the economy, which gives retailers pricing power.
The two kinds of inflation aren't entirely distinct from each other. Cost-push inflation can spill over into demand-pull if demand is strong when an exogenous shock happens, making it easier for retailers to pass on price increases.
Take a depreciation in the rand as an exogenous shock. In an environment of strong demand, retailers can push up the price of just about anything and blame it on the weak rand. The same goes for the petrol price.
But one thing is clear: in the absence of demand-pull inflation, cost-push inflation represents an exogenous shock and a once-off increase in the price level. It's only when there are second-round effects as these price increases are passed on that the Reserve Bank should act.
Marcus' predecessor, Tito Mboweni, made no distinction between cost-push and demand-pull. During the oil and food price shocks of 2007-08, he continued increasing interest rates even though the subprime crisis had already taken hold globally. (The subprime crisis was the root cause of the global financial crisis and refers to loans granted to customers who weren't creditworthy – "subprime" – and subsequently went sour.)
Early on in her statement, Marcus made it clear she was not going to follow Mboweni down the route of killing the economy because the oil price is rising. She said in the very first paragraph: "At this stage there are no discernible inflationary pressures coming from the demand side of the economy."
This is made clear when she gives the figure for inflation excluding administered prices in February, which was only 2.7%. Administered prices include electricity and petrol.
Administered prices excluding petrol rose by 9.1%, showing the extent to which electricity costs are affecting inflation. The overall inflation rate was 3.7% in January and February.
Marcus' inflation forecasts have changed to an average rate of 5.7% in 2012, with inflation expected to peak at 5.8% in the first quarter of 2012 before declining to 5.6% in the fourth quarter. Analysts polled by Reuters expect inflation to average 6% in 2012.
Leeway for the lady to change her mindThe Reserve Bank focuses on 2012 because decisions taken now will affect the inflation rate then. Marcus said the risks to the inflation outlook are on the upside, mainly because of the high oil price, which had already been high before the political crises in North Africa.
She said about the risks to the inflation outlook: "These risks and underlying pressures are mainly of a cost-push nature." But then came the crucial last sentence: "Given the significant upside risks to the inflation outlook, the MPC will closely monitor any indications of second-round effects on inflation emanating from these cost pressures."
So, if retailers should pass on the cost increases easily, leading to a generalised hike in the rate of price increases, the Reseve Bank will act. This seems unlikely in the near term, as the statement also said: "There are indications that, although consumption expenditure growth will remain relatively robust, it is unlikely to accelerate to excessive levels in the short term."
It's when consumption is excessive that retailers find it easy to pass on price increases.
She also noted that there are indications that nominal wage settlement rates may be moderating, with the overall wage settlement rate in collective bargaining agreements amounting to 8.2% in 2010 compared with 9.3% in 2009.
My bet is that those economists predicting interest rate hikes to start in September are wrong. They are most likely to start at the last MPC meeting of the year, or early in the new year. But Marcus has played her cards close to her chest, leaving herself scope to change her mind if she wants to.
Central bankers can never be too clear on what they're going to do. It's up to us to read the tea leaves.
- Fin24