Reserve Bank to give the markets what they want — for now

The Reserve Bank, often accused of being overly conservative, has been rather active since the outbreak of Covid-19. But as always, the question is whether it has done enough, and it’s often subject to unfavourable comparisons with what its peers elsewhere have done.

Its defenders will point to the fact that through an unprecedented quantitative easing programme and various other measures to inject liquidity and facilitate lending in the economy, it has injected about R300bn already.

Cuts of 100 basis points each in March and during an unscheduled meeting in April have taken the repo rate to 4.25%, the lowest since it was introduced in 1998. According to polls from Reuters and Bloomberg, it will do more and add another 50 basis points of cuts on Thursday. At 3.75%, the rate will be 0.35 percentage point less than the March inflation figure.

At the start of the year, with the country facing a fiscal crisis and an imminent ratings downgrade, very few would have predicted that less than six months later SA would be a candidate for negative real interest rates. That this is even a matter of debate is just one of the signs of how Covid-19 has upended the world.

In a normal world, a ratings downgrade followed by an outflow of money from the country’s bond market and a weaker currency would have been followed by debates about interest-rate hikes.

Covid-19 and the virtual shutting of the world economy has changed all that. Inflation is the least of anybody’s worries. Where there are worries about inflation, it is about it slowing to zero or less, rather than it spiralling out of control.

And there are of course very good reasons why the Bank should act again, and the governor, Lesetja Kganyago, has suggested as much. In a webinar arranged by Investec Wealth and Investment earlier in May, he noted that the rand’s drop had been “more than compensated” for by lower oil prices and that  “inflation is not our worry at the moment”.

Of course, he did not waste the opportunity to attribute the Bank’s ability to be flexible in its much-criticised conservatism. The Bank had got “the space to be able to provide support to the economy precisely because inflation is under control”, he said.

Notwithstanding the difficulty of measuring the rate of inflation in a closed economy where some of the objects that make up the consumer price index (CPI) basket are unavailable for sale, the consensus is that the direction of travel is to the downside. In fact, more and more economists are talking about the risks of breaching the 3%-6% target to the downside, hence the call for the Bank to be more aggressive.

Thanks partly to the Bank’s own actions in the wake of the intense market stress in March, this week’s meeting happens in the context of a relatively calm market. The rand is trading at its strongest level in more than a month and 10-year bond yields were at 9%, lower than before the Moody’s Investors Service downgrade in late March and a far cry from their records of more than 13%.

Even with the recent gains, the rand has been one of the hardest-hit currencies in 2020. Some economists have argued that it’s undervalued at current levels, making a sell-off unlikely.

In addition to its inflation and GDP forecasts, markets will be on the lookout for how the Bank assesses the effectiveness of its intervention in financial markets. This will have a bearing on whether it will continue with its bond-buying programme, which it increased by R11bn in April. It might be hard to justify continuing this if the Bank believes it has succeeded in restoring calm to the market, lest it be accused of trying to fund the government through the back door.

With the government’s fiscal space to support the economy severely constrained, the Bank is seen in many quarters as the only game in town. It faces a potentially tricky road ahead as it looks for ways to retreat from its recent adventures.  

Thursday is probably not the time to start and the market will most likely get what it wants and expects. For now.