Inflation is much more destructive once it’s entrenched

FIFI PETERS: More on… local interest rates, given that South Africa’s repo rate is now back to pre-pandemic levels. [Regarding] the latest 75-basis-point rate hike from the Reserve Bank earlier this afternoon, to be honest I’m not entirely sure if this is a great thing, given that the economy is still below pandemic levels and so are jobs. We have not replaced all the jobs that we lost as a result of the pandemic.

But let’s get the view of an expert and a much sharper and cleverer mind than mine, the group chief economist of Nedbank, Nicky Weimar. Nicky, is it a good thing that the repo rate is now back at 6.25% and prime at 9.75% – levels we haven’t seen since January, 2020? Is it a good thing in this environment?

NICKY WEIMAR: I think it is necessary in the sense that nobody wants higher interest rates; we would all want to be in a situation where we’ve got structurally lower interest rates. But I think what the Reserve Bank is fighting here is inflation that is well above target.

We had some encouraging news on that front in August, with inflation easing a bit. But really, going from 7.8% to 7.6%, that’s still well above the 6% upper limit of the target. And remember, from the Reserve Bank’s perspective they are actually targeting 4.5%, which is that middle point of the target range – and it’s miles above that.

So I don’t think they had that much choice. We’ve fought a long, hard battle against inflation in the decades that preceded this moment, and we are now back at a situation where it has risen very sharply to levels we haven’t seen for an extremely long time, and we know what it takes to bring inflation back and reduce inflation expectations, cemented at a lower level. Unfortunately it’s not the best of sciences. It’s blunt. You have to inflict some pain.

But the whole idea is that by using interest rates, by moving them higher – yes, you slow things down, there’s no doubt about that – but in the long run inflation is that much more destructive once it becomes entrenched and, if you want to fight that battle, then it’s much more of an uphill battle and much more painful than moving sequentially at this point.

FIFI PETERS: Yes, probably like the kind of battle the US Federal Reserve is fighting on its end.

NICKY WEIMAR: It’s always exactly the same argument. If you think about it, they actually fell asleep a little bit at the wheel and stuck with a temporary story, even as evidence grew that that was not the case. And now they have to move much more aggressively and much more painfully than if they [had] moved with 25 basis points a shot the moment they started seeing [inflation?] emerge. I think that is probably the Reserve Bank’s argument.

But their hand is also being forced, they are in a global environment that is highly unpredictable, that is putting immense pressure on the currency over time.

Currency weakness translates into greater inflation. So, no matter which way they look at it, it is really a difficult spot to be in. But the evidence is there, there is an inflation problem in South Africa that we need to fight.

FIFI PETERS: There’s also a jobs problem. What people also note when they look at how the US Federal Reserve dealt with their recovery from Covid-19, [is that] they focused on that jobs market and the labour market, and now the jobs picture is even rosier than before the pandemic began. I think I heard someone say that for every unemployed person in the US right now there are two vacancies, two job openings.

NICKY WEIMAR: It’s a tight labour market.

FIFI PETERS: And so to the argument that, yes, they’ve got a big problem with inflation right now, and it’s probably hurting those employed people right now. But what about our argument on our jobs problem, where we are still in a situation where we have not recovered all the jobs lost as a result of the pandemic?

NICKY WEIMAR: There’s some nuance here. I mean, the first point to make is that Covid hit the sectors that are extremely labour-intensive, which are not your goods markets, not your producers, but essentially your services – hotels, travel, restaurants, catering services, coffee shops. It hit them exceptionally hard. They are very labour-intensive and, as they recover, they will employ more people. That’s what we are actually seeing now. That’s what we saw in the final quarter, in the first quarter, and in the second quarter. So in net terms, jobs are rising as those industries and conditions in those industries are normalising.

But of course we have a massive deficit. Even before we entered hard lockdown in April, 2020 we already had a very serious unemployment problem, and that was the highest level of unemployment.

What we need to understand, is it monetary policy alone that is responsible for the situation we find ourselves in? I think if you were to analyse the economy, if you were to break it down, you would know that it is actually not the reason we are not growing fast enough to create more jobs. The real reasons really relate to the issue we have now of energy shortages.

Look at the first half of the year and how we performed; it’s a very predictable story. In the first quarter we grew stronger than expected. It looked like we had some momentum. In the second quarter, what happened? We ran straight into a brick wall, and we slowed down and we shrunk – marginally, but we shrunk.

And yes, the floods are unpredictable. The ramifications of climate change – that’s a new risk we have to deal with. But the rest of the constraints were very predictable, and they mainly centred around the fact that we actually do not have enough energy to grow at a certain level on a consistent and persistent basis. And that’s our problem.

So the energy shortage is the biggest reason we are not growing.

The other reason is that we have a very unreliable and expensive general economic infrastructure – the road, rail, port infrastructure.

Anybody that’s been on the N3 travelling from Johannesburg to Durban will be astounded by the queue of trucks lining up around that Pietermaritzburg area, kilometres of it. And that just shows you that’s not an efficient way of transporting goods to the port.

So all of these things are weighing on us and it has nothing to do with the level of interest rate.

FIFI PETERS: … I do take your point, which made me really curious as to the forecasts from the South African Reserve Bank around growth this year. Maybe I didn’t see it properly, but they haven’t changed their forecast. They’re still expecting 1.9% growth this year notwithstanding what you’ve said.

NICKY WEIMAR: Do you know what happened there? They had a much sharper contraction for the second quarter than actually occurred. I think they were looking at minus 1.2% and it actually contracted only 0.7%. Then they had a stronger rebound that got them to that 1.9% growth rate. Now they have a weaker contraction – that’s the actual outcome in the second quarter – and they’ve got a slower recovery in the second half of the year. That still brings them to 1.9%. So it’s arithmetic. It’s just how the statistics of that play out.

Also there’s a base effect that’s going to make this number look a little bit better this year, because we had that big hit last year in July when we had the riots.

And so your third-quarter number might not be great quarter on quarter. But year on year it’s still going to look spectacular, simply because you’re coming off that ridiculously low base.

And so once all of that noise is out of the system, it’s from next year onwards that we’re going to have a better indication of our sort of underlying growth, I guess. If you look at that, they are saying 1.4% … which is weak.

FIFI PETERS: Is it your expectation also?

NICKY WEIMAR: We’ve actually got a little weaker. The Reserve Bank says that the hike in interest rates will not affect credit demand, it’s still supportive of continued demand for credit and consumer spending. We think consumers are taking a little bit of stress. We look at a variety of indicators. We know that when you hike interest rates, it takes 12 to 18 months to really start to bite.

That takes us around to the middle of next year. We think it’s going to slow down a little bit more than that, so we are somewhere between 1.1% and 1.2% for next year. So we are actually weaker than them.

And we see that weakness really materialising around the middle part of next year, and it’s going to be the cumulative effect of this year’s rise in inflation and of the rise in interest rates. It takes time before it really starts to hurt.

That is our view. They obviously disagree. They believe it’s going to be slightly more buoyant, but they’re also seeing that slow down. They’ve also worked that into their numbers.

FIFI PETERS: You see that argument? It also makes me question. At what point do you take a pause and sit back and actually wait for the interest rate increases that you’ve pushed through the system so far to see what impact they’ve had because, if it’s a lag defect, that 12 to 18 months or so, at what point do you say, okay, let me see what we’ve done so far? I think it’s 275 basis points now, after this latest call. Let’s see what this 275 basis points has done so far before we continue to go, and before we know how to move forward. At what point should the Sarb think about doing that?

NICKY WEIMAR: You see, that is the million-dollar question. I can tell you now they don’t know. We don’t know, and [nor does] anybody who claims to know. This is not an exact science. I remember what [US Federal Reserve chair] Jerome Powell said yesterday: ‘We don’t know either’. They don’t know either.

They know there’s a risk they could overdo it. I think we run that same risk. But you’ve got to kind of weigh up how long it takes to fight inflation. There’s also a long lag there you see. So the argument from central bankers [is] usually ‘because it takes so long for interest rate hikes to impact on pricing behaviour, it’s better to move sooner, get to your peak and stop’. That seems to be a very popular argument, and that’s clearly what the Reserve Bank’s doing, that’s clearly what the other central banks in the world are doing. They’re following that philosophy. But you are quite right to make the point: could you overdo it? Yes, you could. There’s a very strong risk of that.

I think, though, the Reserve Bank is wise enough and watching the economy [so] that, if growth really falls short of their own forecast, they’ll pause and possibly reconsider … the other thing that could maybe make them reconsider is if the world economy were to enter recession.

We know that South Africa always suffers when the world economy enters recession. It’s very bad for demand for commodities, it’s very bad for commodity prices. You tend to see very significant deterioration on that front that becomes a drag on our economy. So I think when that happens they will definitely say, hang on, it’s time to pause, it’s time to stop.

I’m hoping that’s the case, but obviously it’s a very difficult question to answer.

FIFI PETERS: Nicky, I could talk to you forever, but I don’t have forever. I have to go. But thanks very much. I checked the forecast. I’m just looking at that MPC statement. You’re right, 1.4% for 2023 and 1.7% for 2024.

NICKY WEIMAR: That’s right, yes. So it’s slightly better than we’ve got.

FIFI PETERS: Okay. Until next time. Nicky Weimar is the group chief economist at Nedbank.