I attended a lunch today with Brian Kahn, a member of the Monetary Policy (MPC) committee who has been with the South African Reserve Bank (SARB) since 1999. We had met with him a few months ago and he used this meeting to again emphasise that the SARB would follow a conventional inflation targeting framework. He also confronted the issue of the SARB’s communication strategy, given that January’s rate hike was a surprise to all 25 economists polled by Bloomberg. Brian indicated that the MPC had sufficiently communicated the risk of a hike in its two previous hawkish MPC statements, something I had previously highlighted.
A lot of time at the lunch was spent discussing the monetary policy framework, the views of the various committee members, as well as the domestic economy and the effect of interest rate hikes on growth. My interpretation of the SARB’s thinking is that they react primarily to 3 factors:
3) Global Rates/Liquidity
Where I think local economists got it wrong was that they spent a lot of time focusing on the domestic environment (1 and 2). They looked at the poor growth outlook and the relatively muted inflation data and concluded that there was no need to hike rates. Many economists thought that rates would remain on hold throughout 2014. My own view is that global interest rates (3), is the overriding factor, and the SARB doesn’t have as much choice in its policy as it or economists/analysts thinks. The following chart (source: Bloomberg) shows a long term history of SA’s Prime Lending Rate and the FED Funds target rate.
From this 30 year history it is clear that SA rates are very much a function of the global interest rate cycle, of which the FED is the biggest driver. The cycle has been different this time in that the FED resorted to quantitative easing programs once they had reached the zero bound of interest rates. These QE programs achieved their aim of creating liquidity conditions commensurate with a negative Fed Funds rate. Once the FED began the process of tightening monetary policy in May by announcing the tapering of QE, SA rates could not remain at their record low levels and rate hikes were inevitable.