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IN HER last monetary policy committee (MPC) statement, Reserve Bank governor Gill Marcus said oil prices posed the most upside risk to her inflation forecast. Now oil prices have fallen as some of the froth has been taken out of commodity prices.
This doesn't, however, mean that interest rates won't go up at some point, and this week's MPC statement will be read carefully for clues as to the timing of a rate hike. But the fall in oil prices has taken some of the heat off the governor, who will also have one eye on that 25% unemployment rate. That doesn't mean that there isn't heat emanating from other sources, such as wage negotiations.
It might seem to people that it doesn't matter when interest rates go up: the third quarter of this year, the fourth quarter or the first quarter of next year. But when you're in the markets, it can make a big difference. As it can if you're living from paycheque to paycheque.
A Reuters poll of 28 economists is split on the decision. Prominent forecasters such as the Bureau for Economic Research expect interest rate hikes in September and December, as does Citigroup and JP Morgan. Others, such as Brait's Colen Garrow, expects a hike in December, as does Morgan Stanley. Those plumping for January include Absa Capital and Nedbank. It's all very up in the air at the moment.
We mustn't forget what the Reserve Bank's job is: to keep inflation within a 3% to 6% target band without inducing terrible shocks to the economy. In other words, inflation must be kept below 6%, but the Reserve Bank has some flexibility in dealing with the issue.
Marcus' own inflation forecast is for inflation to average 4.7% in 2011 and 5.7% in 2012 – an upward adjustment of about half a percentage point for 2012.
Inflation targeting is necessarily forward-looking, with action taken now affecting the target six to 12 months into the future (some say it takes longer for the effect to take hold - a full 18 months before interest rate action works its way through the economy).
Most economists expect inflation to be near or at 6% at the end of this year or first quarter of next year. Does that not mean that Marcus should be raising rates now, in a pre-emptive strike?
The answer is no, because she has already invoked the flexibility inherent in the targeting process. She argues that because the main pressure on inflation is from food and fuel prices, which aren't affected by interest rates, there's no need for rates to rise yet. There's no sign yet of demand-pull inflation.
Now's the time for a strong warning from Sarb
If there's strong demand in the economy, it becomes easy for retailers to pass on food and fuel price costs to the consumer. Demand in the SA economy has been stop-start, with real retail sales falling month-on-month in February, the latest available figure.
Credit demand has also been slack, with mortgage advances falling 0.5% month-on-month in March, bringing the annual rate of growth in mortgage advances to a paltry 2.9%. Households are still feeling the overhang from debt burdens built up during the boom years.
But demand will pick up as the economy gathers momentum, helping retailers to pass on costs. These "second round effects" were noted in the last MPC statement as a reason to raise rates.
But the main reason why Marcus will raise rates at some point is the need to manage expectations. If inflation nears or breaches 6% and the Reserve Bank is seen to be doing nothing, its credibility will be harmed. That explains why action sometimes coincides with the inflation rate rising, instead of preceding it. It's a way to send a message.
There's one important message that Marcus needs to send, and that's to the unions. If wage increases far outstrip inflation without concomitant increases in productivity, this will heighten demand and make it easy for retailers to pass on price increases. Wages itself represent a cost that will be passed on to consumers.
Unions wage demands are exorbitant. The civil servants' unions are asking for a 9% pay rise – more than twice the current inflation rate. The SA Municipal Workers' Union is demanding an 18% across-the-board pay rise. The National Union of Metalworkers of SA's demand for a 20% increase is the biggest so far. The National Union of Mineworkers is demanding 14%.
Marcus needs to make it clear in her statement this week that the unions' demands are unacceptable. If the unions get away with big pay hikes, an early interest rate increase should be a given. The link needs to be made between inflation and pay hikes, and between pay hikes and interest rates. Marcus has a great opportunity to weigh into the debate this week; she should do so without fear of raising the ANC alliance partners' hackles.
You can't warn about second round effects in one statement and then ignore an important mechanism by which these effects take place – wage hikes. Negotiations have just kicked off, and now is the time to issue a strong warning from the Reserve Bank to the unions.
- Fin24
This doesn't, however, mean that interest rates won't go up at some point, and this week's MPC statement will be read carefully for clues as to the timing of a rate hike. But the fall in oil prices has taken some of the heat off the governor, who will also have one eye on that 25% unemployment rate. That doesn't mean that there isn't heat emanating from other sources, such as wage negotiations.
It might seem to people that it doesn't matter when interest rates go up: the third quarter of this year, the fourth quarter or the first quarter of next year. But when you're in the markets, it can make a big difference. As it can if you're living from paycheque to paycheque.
A Reuters poll of 28 economists is split on the decision. Prominent forecasters such as the Bureau for Economic Research expect interest rate hikes in September and December, as does Citigroup and JP Morgan. Others, such as Brait's Colen Garrow, expects a hike in December, as does Morgan Stanley. Those plumping for January include Absa Capital and Nedbank. It's all very up in the air at the moment.
We mustn't forget what the Reserve Bank's job is: to keep inflation within a 3% to 6% target band without inducing terrible shocks to the economy. In other words, inflation must be kept below 6%, but the Reserve Bank has some flexibility in dealing with the issue.
Marcus' own inflation forecast is for inflation to average 4.7% in 2011 and 5.7% in 2012 – an upward adjustment of about half a percentage point for 2012.
Inflation targeting is necessarily forward-looking, with action taken now affecting the target six to 12 months into the future (some say it takes longer for the effect to take hold - a full 18 months before interest rate action works its way through the economy).
Most economists expect inflation to be near or at 6% at the end of this year or first quarter of next year. Does that not mean that Marcus should be raising rates now, in a pre-emptive strike?
The answer is no, because she has already invoked the flexibility inherent in the targeting process. She argues that because the main pressure on inflation is from food and fuel prices, which aren't affected by interest rates, there's no need for rates to rise yet. There's no sign yet of demand-pull inflation.
Now's the time for a strong warning from Sarb
If there's strong demand in the economy, it becomes easy for retailers to pass on food and fuel price costs to the consumer. Demand in the SA economy has been stop-start, with real retail sales falling month-on-month in February, the latest available figure.
Credit demand has also been slack, with mortgage advances falling 0.5% month-on-month in March, bringing the annual rate of growth in mortgage advances to a paltry 2.9%. Households are still feeling the overhang from debt burdens built up during the boom years.
But demand will pick up as the economy gathers momentum, helping retailers to pass on costs. These "second round effects" were noted in the last MPC statement as a reason to raise rates.
But the main reason why Marcus will raise rates at some point is the need to manage expectations. If inflation nears or breaches 6% and the Reserve Bank is seen to be doing nothing, its credibility will be harmed. That explains why action sometimes coincides with the inflation rate rising, instead of preceding it. It's a way to send a message.
There's one important message that Marcus needs to send, and that's to the unions. If wage increases far outstrip inflation without concomitant increases in productivity, this will heighten demand and make it easy for retailers to pass on price increases. Wages itself represent a cost that will be passed on to consumers.
Unions wage demands are exorbitant. The civil servants' unions are asking for a 9% pay rise – more than twice the current inflation rate. The SA Municipal Workers' Union is demanding an 18% across-the-board pay rise. The National Union of Metalworkers of SA's demand for a 20% increase is the biggest so far. The National Union of Mineworkers is demanding 14%.
Marcus needs to make it clear in her statement this week that the unions' demands are unacceptable. If the unions get away with big pay hikes, an early interest rate increase should be a given. The link needs to be made between inflation and pay hikes, and between pay hikes and interest rates. Marcus has a great opportunity to weigh into the debate this week; she should do so without fear of raising the ANC alliance partners' hackles.
You can't warn about second round effects in one statement and then ignore an important mechanism by which these effects take place – wage hikes. Negotiations have just kicked off, and now is the time to issue a strong warning from the Reserve Bank to the unions.
- Fin24
