Higher international interest rates will be necessary to tame inflation!

The global economy has – up to now – stood up well to what would have been warranted by the strong increases in interest rates instituted by central banks. But such resilience and stronger economic growth can be explained. However, this implies higher increases in interest rates will be needed than anticipated in December 2022. Unfortunately, South Africa will not share in the stronger than anticipated global economic performance, but more interest rate increases may be necessary to combat a renewed bout of CPI.

January numbers in the US show lower unemployment, an increase in disposable income, higher consumption expenditure, more saving, more credit card debt and slower decline in consumer price inflation (CPI) – despite fast and aggressive increases in interest rates. Real disposable personal income increased by 1.4% from December to January, mainly because of the surge in employment and once off 8.7% cost-of-living adjustment in Social Security payments. This explains the 1.1% increase in consumer spending from December to January as well as the rise in the personal savings rate from 4.5% in December to 4.7% in January. These numbers explain why core CPI increased by 0.6% from December to January and year on year from 4.6% in December to 4.7% in January. Consequently, markets are pricing for a terminal rate of 5.5%, some 50 basis points higher than the expectation in December 2022.

Eurozone real GDP grew 3.5% in 2022, better than the 2.1% of the US and 3% of China. The economic outlook is also much better compared to a few months ago when energy shortages looked inevitable. However, mainly due to a mild winter, and gas imports from elsewhere, gas prices declined to levels before Russia’s invasion of the Ukraine. Consequently, CPI was up 8.6% in January year on year, down from 10.6% in October. However, when volatile food and energy prices are stripped out, core CPI was up 5.3% in January, a record high. Given the surprising resilience of the European economy, tightness of the labor market, and high core CPI, the European Central Bank will continue raising interest rates.

The UK’s economic outlook also improved due to better news on energy supply, CPI and the improved economic outlook for the US, Eurozone and China. Although the UK is still expected to experience a recession, it should be milder and shorter than previously estimated by analysts. UK inflation is running at 10.5% but has probably peaked. Nevertheless, the Bank of England is expected to raise interest rates further following the latest 50 basis point increase.

Although China’s economy appears to be recovering fast, many headwinds could curtail economic growth in the coming decade. These can be clustered into three buckets: demographics (slow population growth), government policy regarding the state versus private sectors, and external constraints limiting technology acquisition and growth. The first and last are largely beyond the control of the government, but how it approaches these issues will determine China’s growth outlook.

Good news in South Africa is that government finances returned to a “going concern” when tax income exceeded expenditure excluding debt repayments in 2022/23. Although the national budget will continue to face headwinds in the next three years, government’s decision to take over 60% of Eskom’s debt is an encouraging step. Nevertheless, continuous load-shedding for at least the next two years, high and sticky CPI and a weaker exchange rate due to among others the country being “greylisted” by the Financial Action Task Force, dampened more positive expectations. Economic growth is forecasted to slow to around 1% in 2023 from 2.5%, with at least one more interest rate increase in the offing.

Multivest Economic Division