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Distinctly More Hawkish MPC
Ettiene Le Roux
8 June 2007
After leaving rates unchanged in January and April, the MPC decided today to raise the repo rate by a further 50 basis points to 9,5%. In our commentary on the April MPC statement we argued that considering the long list of factors spelt out by the Committee that were negative for the future course of inflation, as well as the higher inflation forecast which the Committee had in April compared to February, the decision could just as well have been to raise interest rates as keeping them unchanged.
With the wisdom of hindsight, that is perhaps exactly what the MPC should have done: every piece of subsequent inflation-related news has been bad. Against the MPC's expectation, CPIX inflation breached the upper limit of the target band in April (the April number was even higher than the least likely number in the MPC's 'fan chart' of probable outcomes). While higher oil and food prices (against which monetary policy is powerless) played a role in this, the underlying trend in inflation (as measured by the index which excludes food and energy) also accelerated. Services inflation has increased steadily and producer price inflation rose sharply, and over a wide spectrum.
Since all of this occurred in the past, why did the MPC find it necessary now to raise the repo rate by 50 basis points?
The reason lies in the fear that the recent acceleration in inflation may spill over into more generalised inflation in the quarters ahead. The Bank now forecasts that CPIX inflation will remain marginally above the upper limit of the target range in the current quarter, then to dip for technical reasons in the third quarter, before again slightly exceeding 6.0% in the subsequent two quarters. Inflation is now projected to peak at an average rate of 6.3% in the first quarter of 2008, before declining somewhat to an average of 5.3% in the final quarter of next year.
This forecast is materially higher than the one the Bank had in April. In addition, the MPC identified only upside risks to the outlook. Upside risks noted were food and oil prices as well as continued high rates of growth in household consumption expenditure. In our view things may, however, turn out even worse than the Bank is projecting. During the press conference after the event the Governor indicated that the likelihood of sharply higher electricity tariffs and salary and wage adjustments - which may follow from the current labour market unrest - had not been factored into its revised forecast. The MPC was clearly in a difficult position, not being able to publicly project what these politically sensitive factors would do, nor to be seen to be acting pre-emptively.
With the Committee taking the view that the risks to inflation prospects are 'strongly' on the upside, noting that price pressures have become more 'wide spread' and that inflation expectations have deteriorated, there is a real chance of a further 50 basis point repo hike in August.
Original article published at www.fnb.co.za.
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