Comment on the MPC decision by Jac Laubscher, Sanlam GroupEconomist

The decision by the Monetary Policy Committee to raise the repo rate by 50 basis points to 8,5% has come as no surprise, except for those people who were punting an increase of 100 basis points. The increase is in line with governor Mbowenis earlier comment that interest rates would be adjusted in an orderly manner. It is also the appropriate path to follow, signalling that the Reserve Bank is well in control.

The MPC statement did not contain any real surprise in view of the message that had been projected consistently by the SARB in recent weeks. The decline in the year-on-year rate of increase in unit labour costs to 3,2% in Q2 2006 is nevertheless to be welcomed, and has probably contributed, along with lower fuel prices, to the SARB now forecasting the peak in inflation to be lower than previously thought.

The balanced way in which the SARB is approaching the problem it faces is commendable. The need is after all not to drastically curtail economic growth, but rather to switch its composition onto a more sustainable path with consumption expenditure contributing less and investment spending more.

With regard to the current account deficit, the problem is not only a matter of excessive demand, but also of disappointing growth in exports. Addressing the current account problem can therefore not be left to monetary policy alone, but the production side of the economy also needs urgent attention to remove the bottlenecks that are constraining exports.

The attention will now shift to whether a possible further increase of 50 basis points in the repo rate in December 2006 will be the last in the current cycle. Although an increase in December appears highly likely, any further increase will depend on the data as it becomes available.

However, it is worth noting that one further increase, together with CPIX inflation of approximately 6% as forecast by the Bank, will result in a real repo rate of approximately 3%, which is slightly higher than the real rate of just more than 2% at the peak of the 2002 tightening cycle. At the same time the expected rise in inflation in the current cycle (+3 percentage points) is expected to be much less than in 2002 (+5,5 percentage points). In the absence of any negative surprise, the next hike in the repo rate could therefore well be the last.