Wisdom needed as we close in on the peak of interest rates

Interest rate policy has shifted to a phase where good risk-management has become the focal point. Central banks must reduce the risk of high consumer price inflation (CPI) via higher interest rates – input cost pressures are rising again – but at the same time ensure they don’t act too soon and too much and increase the risk of a hard landing. If they act too soon, it increases the risk of unnecessary rate increases, hurting the economy. If they act too late, CPI will be harder to contain, increasing the risk of several more rate increases, also hurting the economy.

The above situation is especially relevant to the United States of America (US). Cpi is down to 3.2% in July, way lower than its peaks last year, but still above the target of 2%. Yet, interest rates work with a lag through the economy which poses the question whether the Federal Reserve will pause again at its September meeting. This is complicated more by the strong economic growth of 2.1% in Q2 2023, which makes the Federal Reserve uneasy. In addition, the recent Purchaser Management Index (PMI), although slowing and pointing to lower economic growth, also revealed rising wage pressures, which if spilled over into higher CPI, may prompt another rate increase. At this stage, it however seems as if the Federal Reserve will pause again in September, given the declining composite PMI and CPI. Should the situation not improve further, rate increases may resume in October/November.

Europe – and the United Kingdom - have a more severe problem compared to the US as their economies are under pressure, while price pressures are increasing. In the Eurozone the composite PMI decreased from 48.6 in July to 47 in August, a 33-month low, pointing to a high likelihood of the economy (especially Germany) shrinking in Q3 2023. However, the PMI also registered higher input- and output prices, mainly due to rising wage pressures. The UK is experiencing a similar but even worse pattern. The composite PMI declined from 50.8 in July to 47.9 in August, while input prices increased, and unemployment rising. The European Central Bank and Bank of England are therefore in a difficult situation as they must deal with high CPI, pressure on CPI to increase and an economic contraction.

China’s economy continues to under-perform, following quarter on quarter growth of only 0.8% in Q2 2023. Import and export growth rates are tumbling, which will negatively affect China and the rest of the world’s economic growth rates. Should China’s growth falter further, together with that of the US and Europe, a world economic recession is not out of the question. However, a silver lining is deflation and a weaker currency in China, which makes imports from China cheaper. This should assist other central banks in their challenge to bring down CPI and marginally reduce the pressure to increase interest rates.

The most notable outcome of the BRICS-summit held in South Africa was an invitation extended to Argentina, Egypt, Ethiopia, Saudi-Arabia, United Arab Emirates, and Iran to join. Should these countries join, it will increase the group’s share of World Gross Domestic Product from 26.2% to 29.2%, closer to the 43.5% of the G7-countries. In addition, it was decided to increase trade between the countries and to extend local currency loans – both aimed at reducing the grip of the US$ on the countries.

South Africa’s CPI receded strongly from 5.4% in June to 4.7% in July, mostly due to lower-than-expected property tax increases instituted by local governments and lower fuel and food price increases. However, a sharp increase in fuel prices (due to a weaker rand and higher oil prices) may push the CPI back towards 5%, but no interest rate hike is expected in September – meaning interest rates will remain high for longer. In the meantime, the Reserve Bank found no contravention of exchange control (and money laundering) laws regarding the theft of foreign currency at president Ramaphosa’s Phala Phala farm.

Multivest Economic Division