New world future

Systemic inefficiencies in the form of higher prices, interest rates and lower growth

Economic policy around the world has changed from the efficiency prescriptions of the “Washington Consensus” aimed at low inflation and sustainable economic growth, to more “subsidies, protectionism, and bloc alignment”. The latter means inefficiencies will be tolerated – and therefore that at least the short-term economic future will be characterised by loftier prices, higher interest rates and slower economic growth.

This new economic policy trend – mostly driven by national security issues aimed at de-risking supply chains – is already visible in the USA, Europe, and China, while the war between Russia and the Ukraine is accelerating the new policy changes. The effects are visible in stickier consumer price inflation (CPI). CPI should eventually return to targets, but price levels will be higher. And although the impact on economic growth will only be visible in years to come, interest rates will not be lowered to levels commensurate with policies aimed at the efficient allocation of resources and supply chain optimization.

Central bankers of countries/regions who mostly determine market changes, namely the USA, Europe, UK, and Japan indicated as much at the ECB Forum on Central Banking last month. They agreed that future monetary policy decisions will be data driven and that they will do what is needed to bring CPI down to target levels as soon as possible – despite the near-term damage to households. While most indicated more rate increases, the outlier was Japan, who pointed to no change in interest rates as it is believed higher interest rates will not be effective to counter the current type of cost-push inflation.

However, this is not the case in the USA. Although interest rates were not raised at the previous MPC-meeting, and a case can be made to pause, the decision at the previous meeting should be seen as a “skip” and not as a “pause”. The case for a pause emanates from excluding food and housing from CPI. When that is done, CPI for May is just 1% instead of 4%. The reasoning is price increases in these two items will over the next six months or so slow substantially. However, resilient economic growth, which at 2% in Q1 2023 was almost double the initial estimate, is a concern to the Federal Reserve as high wage increases may cause CPI to remain sticky for longer. Another rate hike of 25 basis points later this month, and again in October/November therefore seem plausible.

Following May’s CPI of 6.1%, the ECB pointed to another rate increase in July after hiking by 25 basis points in June. The Bank of England increased rates by 50 basis points (more than the usual 25 basis points) as CPI remained high at 8.7% in May. A problem for the UK is that it is the third-largest food importer in the world and is therefore more vulnerable to global commodity price shifts. Food prices in the UK was up more than 18% in May.

A myriad of economic indicators is pointing to a weaker than expected Chinese economy. Monetary policy has become more supportive through a series of interest rate cuts and reductions in reserve requirements. However, a fiscal stimulus has not yet been forthcoming, as was widely expected. This may happen in July.

South Africa’s CPI also slowed to 6.3% in May, but the MPC is set to raise rates by another 25 basis points in July – mostly to reduce the impact of a weaker rand on future CPI. Somewhat better news on the electricity front is less load-shedding, which may bolster economic growth somewhat. However, all indicators point to a struggling consumer, following high CPI and interest rates as well as low job creation.

Multivest Economic Division