A Repeat Performance from the MPC

A Repeat Performance from the MPC

In my commentary after the previous Monetary Policy Committee (MPC) meeting (dated 1 July 2009), I lamented the fact that private sector analysts and the South African Reserve Bank (SARB) were clearly not on the same page, judged by the fact that the MPC’s decision to keep the repo rate unchanged surprised the vast majority of analysts, with the consensus view being that it would be cut by 50 basis points. To me there was a clear need for the SARB to reconsider its communication strategy.

Yesterday’s decision by the MPC to reduce the repo rate by 50 basis points was a repeat performance, with 23 out of 26 analysts polled by Reuters expecting no change. The analyst community and the SARB therefore clearly remain out of synch in their thinking. The only ray of hope that the divide could be narrowing is that this time the decision was a close call according to the governor of the Bank, whereas the MPC spent very little time discussing the possibility of cutting the repo rate at its previous meeting, again à la the governor.

Analysts apparently took to heart the stern warning in the final paragraph of the MPC Statement of 25 June 2009 that “the Committee is fully cognisant of the fact that there has been significant monetary accommodation since December 2008”, with some judging this to signal the end of the rate-cutting cycle, and others judging it to mean that the SARB will only reduce the repo rate further if its forecasts turn out to be significantly wrong.

The question then is: What made the MPC change its stance since its previous meeting? A comparison of yesterday’s MPC Statement with the previous one unfortunately sheds little light on the matter.

• According to the latest statement, the SARB’s inflation forecast “remained more or less unchanged compared with the previous forecast”. One would thus expect an inflation-targeting central bank to have maintained its policy stance, and the fact that this has not been the case therefore points to other considerations swinging the balance in favour of a rate cut.
• However, in motivating its decision, the MPC states that “notwithstanding upside cost pressures, the adverse economic conditions appear to tilt the balance of risks to the inflation outlook towards the downside over the medium term.” Apparently the Committee this time attached greater weight to the widening output gap (the difference between actual and potential output) to which it also alluded in June.
• But is this a valid reason? In my view the fact that cost-push pressures remain the main upside risk to inflation while the economy is in recession (viz. while demand is weak) points to the irrelevance of this argument. This conclusion is further underlined by real wage increases being higher now than last year in spite of rising unemployment, which is a standard measure of growing slack in the economy.
• The consensus view is that the SARB is responding to the weakness in the real economy. Could it be that the MPC took to heart recent weak economic data, e.g. on retail sales and the Kagiso/BER Purchasing Managers Index? It states that “domestic economic conditions remain subdued amid indications that the economy contracted further in the second quarter of 2009.” But this is not unexpected, as the June MPC Statement says that “the negative trend in GDP growth is likely to have continued during the second quarter of 2009.”
• Compared to its previous statement, the MPC points out that the outlook for the global economy appears to have improved. However, it then states that “the South African economy appears to be lagging behind these international developments”.