South African monetary policy remains in a tightening cycle

Investors looking for a clear signal of where South African interest rates are headed will be disappointed with the Monetary Policy Review (MPR) released on Monday, as the monetary policy trajectory “remains in a tightening cycle, although this is subject to data outcomes”.

The South African Reserve Bank (SARB) has now raised the main policy rate, the repo rate, by 200 basis points since January 2014 to 7.0 percent, but it noted that this is at the consumer inflation rate of 7.0 percent year-on-year (y/y) reached in February 2016, so the real policy rate is zero.

The MPR said a clear price stability objective implemented within a flexible inflation-targeting framework is central to its approach to monetary policy.

The central projection of the South African Reserve Bank’s (SARB) inflation forecasting model is for consumer inflation to peak at an average of 7.8 percent y/y in the fourth quarter of 2016 and then to decline gradually to average 6.4 percent in 2017.

The SARB’s inflation target range is from 3 percent y/y to 6 percent y/y. The MPR notes that the risks to the central projection are viewed by the SARB as being skewed slightly to the upside. The uncertainty regarding future developments in cost-push factors such as food and energy, as well as the exchange rate, pose an upside risk to the outlook, which in the view of the SARB more than offsets the downside risks from subdued domestic demand.

For many years, central banks have focused primarily on their monetary policy objective and introduced inflation targeting as a panacea to insure price stability. However, the Great Recession that began in 2007 has seen a rethink, with an increased emphasis on financial stability.

The increasing interdependence of economies and interconnectedness of the global financial system has led to significant financial stability initiatives culminating in the Basel Three proposals. These structured initiatives have developed standards that are material to the strengthening of the global financial system.

The cost of the recent financial crisis has been significant. According to the International Monetary Fund direct costs of banking crises in the past 15 years exceeded 10percent of the gross domestic product in more than a dozen cases.

South Africa has weathered the Great Recession better than most economies due in part to lessons learnt from previous crises, which is why its financial system is rated amongst the most stable in the world.

Unfortunately weather-related problems such as the 21015/16 drought remain outside its power, so it can do little to moderate food or energy prices, while it notes that although capital flows to emerging markets remain strong over the medium term, short-term flows have in recent months been volatile due to the heightened uncertainty caused by political developments.