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Blog : 3 November 2016 (One hopes that the Reserve Bank's inflation forecasting is better than their economic forecasting)
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One of the topics we have written about regularly is the South African Reserve Bank (SARB) interest rate setting policy. Just what exactly are they looking at when they meet during their MPC meetings? The MPC does not provide merely as much detail regarding their meetings as the FOMC in the USA is for example. The question then becomes what exactly is SARB looking at and discussing at these meetings? Do they get inputs from outside such as economists in the private sector whom can give a different perspective to SARB?
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Hope SARB's inflation indicators are better than their economic indicators
The graphic below shows SARB's business cycle indicators compared to the actual economic growth figures
Business cycle indicators (BCI) are used in order to predict the direction of the economy. There are usually three types of BCI's: They are leading, coincident and lagging indicators.
The above graphic was calculated using SARB's (BCI). The GDP numbers where indexed and 2010=100 to ensure it matches that of the BCI. Looking at the graphic above it is clear that none of SARB's business cycle indicators does a very good job in predicting the actual GDP. The leading indicator 's index level dropped to 92.8 in June 2016 compared to GDP index level that is sitting at 111.7. Essentially the leading indicator has declined by 7.2% since 2010, while South Africa's economy has grown by 11.7%
The coincident indicator in stark contrast to the leading indicator shows the strongest increase of all the variables. By June 2016 it's level was at 117.5. Basically it has grown by 17.5% since 2010 while the economy has grown by 11.7%. The difference between the coincident and leading indicator by June 2016 is a massive 24.7%. The lagging indicator while being below the level of GDP and showing -2% since 2010, is still a better indicator of GDP than the leading indicator. While looking at index levels as we did above is useful in showing the underlying trends in the various indicators, we will take a the index level growth rates year on year next.
The above graphic was calculated using SARB's (BCI). The GDP numbers where indexed and 2010=100 to ensure it matches that of the BCI. Looking at the graphic above it is clear that none of SARB's business cycle indicators does a very good job in predicting the actual GDP. The leading indicator 's index level dropped to 92.8 in June 2016 compared to GDP index level that is sitting at 111.7. Essentially the leading indicator has declined by 7.2% since 2010, while South Africa's economy has grown by 11.7%
The coincident indicator in stark contrast to the leading indicator shows the strongest increase of all the variables. By June 2016 it's level was at 117.5. Basically it has grown by 17.5% since 2010 while the economy has grown by 11.7%. The difference between the coincident and leading indicator by June 2016 is a massive 24.7%. The lagging indicator while being below the level of GDP and showing -2% since 2010, is still a better indicator of GDP than the leading indicator. While looking at index levels as we did above is useful in showing the underlying trends in the various indicators, we will take a the index level growth rates year on year next.
The bar chart above shows the year on year percentage changes of the various business cycle indicators and South Africa's GDP (the red bar). From this it is pretty clear that none of the BCI's comes even close to prediciting the year on year percentage changes in South Africa's GDP. Some of the indicators are even showing strong negative movements while the GDP shows positive growth. So the question we have is just how useful is this information? And is SARB actually looking at these numbers as part of their MPC discussions? If they are they should stop. As these numbers does not provide any sort of guidance as to where the South African economy is heading. And if SARB's economic indicators are so far off the mark, the next question is just how far of the mark are their inflation estimations and indicators?
Without accurate predictions and forecasts for inflation SARB and their monetary policy setting is a total lottery and decisions taken there might as well be based on MPC members throwing darts at a board and which ever part of the board gets the most darts thats the policy stance. We have asked this question before and we will ask again. What exactly is SARB looking at when setting interest rate policies, because of their inflation predictions are as far off the mark as their business cycle indicators our monetary policy is based on questionnable indicators to say the least?
The graphic below shows the "evolution" of SARB's inflation forecasts from the January, May and Septemeber 2016 meetings.
The graphic below shows the "evolution" of SARB's inflation forecasts from the January, May and Septemeber 2016 meetings.
What is pretty clear that their Q3: 2016 estimate is well below where inflation looks to be ending Q3:2016. Based on two of the three months in Q3:2016 the average inflation rate is sitting at 6%, while in January 2016 SARB expected it to peak at 7%. Off target by a whopping 100 basis points (or 16.7%). By May 2016 when it became clear their inflation forecast was well off, the forecast for Q3:2016 was adjusted to 6.8%. Still 80 basis points off the current level. And in September 2016 armed with even more information and data available, the forecast for Q3:2016 was lowered from the May 2016 level forecast of 6.8% to 6.2%. Even their January 2016 prediction for Q1:2016 which was at 6.1% was well off the actual level for Q1:2016 (which was 6.5%).
The general drop in the level of SARB's inflation forecasts from January 2016 (the blue line) to the September 2016 (the yellow line) has given hope to analysts and economists that there might possibly be a interest rate cut before we see an interest rate increase again. Problem is the high estimate of future inflation in January lead to interest rate increases (in both January 2016 and March 2016) that when looking at the September 2016 forecast was not warranted by SARB.
While it is notoriously hard to forecast inflation levels, one has to think that SARB with some of the greatest economic minds in SA, and a wealth of data and resources available to them can do a better job of predicting future inflation levels as its critically important for them to do so as monetary policy setting is largely dependent on SARB's view of future levels of inflation.
The general drop in the level of SARB's inflation forecasts from January 2016 (the blue line) to the September 2016 (the yellow line) has given hope to analysts and economists that there might possibly be a interest rate cut before we see an interest rate increase again. Problem is the high estimate of future inflation in January lead to interest rate increases (in both January 2016 and March 2016) that when looking at the September 2016 forecast was not warranted by SARB.
While it is notoriously hard to forecast inflation levels, one has to think that SARB with some of the greatest economic minds in SA, and a wealth of data and resources available to them can do a better job of predicting future inflation levels as its critically important for them to do so as monetary policy setting is largely dependent on SARB's view of future levels of inflation.