Rumours about of a possible deal between the US and Iran (on Monday 25 May), but will it influence Thursday’s repo rate decision?
First off, the Monetary Policy Committee needs to account for the increase in consumer price inflation in April. The inflation rate rose from 3.2% to 4% in April. This is mainly attributable to the first round of fuel price increases. That was an 18.2% month-on-month increase, and fuel prices were 11.4% higher compared to April last year.
There were still significant increases in meat prices at 9.4%, but average food price inflation was lower. The prices of electricity, gas, and other fuels rose by 8.2%, and water by 7%. Other notable year-on-year increases were for package holidays (naturally the cost of those airline tickets) and hotel accommodation (although this decreased month-on-month). An interesting fact is that the higher spending groups and the Western Cape experienced higher inflation rates.
The MPC becomes concerned when a price shock turns into an inflationary process. If it’s only fuel prices that are increasing, they can still look past it, but if other prices start rising and then wage demands start increasing, there’s a problem. At the moment, it’s still too early to say there is general and sustained pressure on prices, but the core inflation rate, which excludes food and fuel prices, rose from 3.2% to 3.6%. A large part of this comes from services, where inflation rose from 4.2% to 4.6%.
The price pressure, however, does not come from excess demand. April’s PayInc index showed that consumers are under pressure and cutting back on other spending to absorb the higher fuel costs. The impact on businesses is also already visible. ABSA and the Bureau for Economic Research’s purchasing managers’ index shows that businesses stockpiled inventory in April in anticipation of rising costs. This tells me that sellers realize they can’t simply pass on cost increases as price increases, and are therefore making plans to absorb a portion of the cost increases.
Even though the inflationary pressure comes from the supply side, it is already being discounted in bond markets. Globally, yields on 10-year debt instruments are rising. This also explains what is happening with the gold price. As “long” interest rates rise, gold loses some of its appeal. Nobody wants to hold too much value in something that doesn’t pay interest when interest rates are rising. This could have different consequences for the exchange rate: a lower gold price could weaken the rand and make imports more expensive, but if long rates rise faster here than in the US, our bond market and the rand could benefit from the so-called “carry trade.”
The Monetary Policy Committee’s decision is a weighing of costs. On one side is the loss of economic growth momentum if the repo rate is raised prematurely. On the other side is the loss of their inflation-fighting credibility if the repo rate is raised too late. One could surely ask, what economic growth? It’s that little bit still being driven by low interest rates and consumer spending. I don’t think we need to wonder about the Reserve Bank’s credibility — everyone knows they will do what it takes to get inflation low again. I therefore think they can afford to keep the repo rate unchanged one more time. After May’s policy committee meeting, the next one is in July. Perhaps the war will be over and everything will look different. If that’s not the case, raise the repo rate then.