Did the SARB make the right call?

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By Cees Bruggemans, Chief Economist FNB.

Did the SARB make the right call last week?

It decided to keep interest rates unchanged, on the premise of inflation being projected inside the target zone over most of the next two years, with a sense of ‘balanced’ risk to the forecast.

To the extent that one believes the SARB should make all ships rise, even the rotting hulks, by stimulating demand to the point of triggering a much happier spending climate, the SARB obviously disappointed.

Or to the extent that one believes the Rand can be made to weaken to much lower preferred levels by increasing domestic resource absorption and lower our attractiveness to the global carry trade (though faster growth would be a renewed attraction), one would have been similarly disappointed.

As to those wishing for inflation convergence with OECD brethren, if necessary at any cost, the disappointment of being refused much higher interest rates must have been even more palpable.

That leaves the rather more mundane question whether the SARB erred on its inflation forecast, or more pointedly (for that is where the shoe pinches most) its sense of risk to the inflation forecast.

Given everything we know and believe (taking a rather broad sweep through the forecasting fraternity where groupthink tends to prevail) the SARB forecast could only be really wrong if there is something out there (nearly) all of us have missed.

Oil? Food? Rand? Global inflation? Weak economy? Although there is some variation between views, in some instances even to the fourth decimal point, it may not be crucial enough to shake the forecast, never mind the policy stance, given a 3% target range (3%-6%)?

Still, the jury is out – on oil ($50 or $150 next year instead of $80?), the Rand (5:$ or 8:$ rather than 6.50:$, never mind 9.50:$?) and a few other neutrals or even positives.

That leaves the negative risks. But even here there are probably few forecasters that will take a contrarian view on what electricity tariff increases are coming, what the second round effects will be, or what wage behaviour to expect beside what is staring you in the face daily.

Yet there was a very pointed, telling remark by Governor Marcus in her MPC presentation last week. Apparently the uncertainties surrounding the electricity issue are such that they (the SARB’s MPC) could not allow a different approach to be taken at this time (no emphasis added of any kind as none is needed, with all of it rather significant).

So, yes, will Eskom be worse than our best nightmares? Or will the outcome be better than ever imagined, not least because the politicians finally get imaginative by preventing too much of a tariff loading (getting Eskom the needed money elsewhere, Eskom slowing down or a combination of these)? And the second round effects being minimal in a struggling economy?

The best advice here is to keep praying while preparing for the worst. That way one cannot be disappointed and only be pleasantly surprised by actual events.

As to wage behaviour, there could be potential for surprise, though perhaps less obvious to the political insiders exposed to the full brunt of union demands.

If one believes in the disciplines exerted by a global market system and weak domestic economy, it is difficult to see how high wage trends can be sustained. But then politically these are trying times and impossible demands may well be rewarded, at least for too long.

The trade-off between high wage demands and low wage bill maintenance is a difficult one to call. But there is room for surprise, unfortunately either way.

So the bottom line seems simple. More time is needed to get technical clarity on these scores (and others, as oil, food, the Rand, the economy and the world won’t remain benign for our inflation forever). And also on the mandate issue (though that may ultimately turn into a fine exercise of beautiful semantics and very high prose as some more political accommodation is sought and found between the many social partners wishing a say here).

So, yes, for credibility sake as a new SARB Governor took office, and due to huge uncertainty in specific areas of the inflation forecast, doing nothing to the policy stance was probably the better call, even in a weakly performing economy knowingly incurring growth sacrifice.

Besides, one wouldn’t want to send the wrong political message by being seen to oblige those vested interests calling rather pressingly for (large) interest rate cuts as the answer to all (their) problems. Instead, one may seek high ground from which to survey all the issues and timely make the right call, if one is eventually needed, rather than be seen caving in to this or that interest at the first opportunity.

Whether doing nothing also remains the policy call in January, March and May 2010 remains to be seen. The market already thinks so, nearly immediately removing the chance of another rate cut from its pricing next year.

As to reality and events, they will march on and give the MPC fresh cause to stress-test its views in 2010, and if need be to make (probably minor) corrections to the policy stance as it currently stands.

And thus we wait, for new data and fresh insight, but also a new sense of risk (a matter of judgment mostly). Whether that will keep calling for the same policy decision, only time can tell.

Source: Cees Bruggemans, FNB, November 22, 2009.

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