Anchor’s Coffee Table Economics note by Casey Delport will be distributed intermittently and is a collection of Casey’s opinions on key economic factors and events shaping markets globally and in South Africa (SA). It is essentially Casey’s thoughts and perspectives on the multiple dynamics at play in the global and local economy.
Executive summary
In this week’s edition, we highlight the following:
- Central banks hold the hawkish line: Last week was all about central bank action, with central bankers in the US, the UK, Japan, Switzerland, and South Africa ([SA], more on that below) opting to hold interest rates, albeit accompanied by increasingly hawkish messaging. There does not appear to be any rush by monetary policymakers to cut rates – indeed, markets have seemingly finally caught up to the narrative of higher-for-longer – a reality many economists have warned about for some time.
- A cautious SARB holds its breath as fuel prices start to reek. The SA Reserve Bank (SARB) looked through the first-round inflation impact of the latest supply-side shocks last week and kept the repo rate on hold at 8.25%. Indeed, the renewed upside risks from rand weakness and higher global fuel and food prices will likely keep the possibility of modest further tightening alive in the last Monetary Policy Committee (MPC) meeting for the year, which takes place in November.
- A Game of (energy) Thrones: Coal still reigns supreme. As the world grapples with the challenges of climate change and seeks to provide access to reliable and sustainable energy, coal, unfortunately, continues to lead the charge when it comes to electricity, representing 35.4% of global power generation in 2022. However, even as non-renewables continue to reign supreme in the global energy landscape, their days are slowly numbered.
Central banks hold the hawkish line
Last week was all about central bank action, with central bankers in the US, the UK, Japan, Switzerland, and SA (more on that below) opting to hold interest rates, albeit accompanied by increasingly hawkish messaging. The decision to hold in the UK and Switzerland was somewhat of a surprise, with financial markets expecting another 25-bp hike from the Bank of England (BoE) and Swiss monetary authorities. In a relatively close call, the BoE voted to keep its policy rate steady at 5.25%, with five of the nine members voting for no change in the policy rate, while four voted for a 25-bp increase. In addition, the Committee unanimously agreed to decrease the amount of UK government bond purchases made for monetary policy purposes, financed by issuing central bank reserves. Explaining its rationale for maintaining the policy rate at its current level, the central bank highlighted the swifter-than-anticipated decline in inflation compared to its August projections. The BoE also emphasised that it anticipated a near-term reduction in the Consumer Price Index (CPI) inflation due to a YoY decrease in energy inflation and continued declines in food and core goods prices. Despite acknowledging that the ongoing increase in oil prices poses a potential inflationary threat, it pointed out that base effects are expected to constrain annual inflationary increases. More importantly, the BoE acknowledged that monetary tightening has impacted the labour market and momentum in the real economy. As such, it deems the current monetary policy stance to be restrictive. Whilst many market participants have viewed this as an indication that the BoE has reached the end of its hiking cycle, the bank was at pains to emphasise that if there is evidence of persistent inflationary pressures, monetary policy would need to be tightened further. It is worth noting that policy must be sufficiently restrictive long enough to sustainably return inflation to the 2% target over the medium term.
Moving across the Atlantic, the US Federal Reserve’s (Fed) Federal Open Market Committee (FOMC) left the Fed funds rate at 5.25%-5.50% during its meeting, as widely expected. Whilst the decision did not come as much of a surprise, the tone of the Fed’s statement and its policy outlook rattled financial markets as the bank maintained its hawkish stance, reiterating that further policy rate hikes could not be ruled out. Moreover, the Fed now expects fewer rate cuts in 2024, i.e., a shallower cutting cycle than initially projected. What has changed, you may ask? Well, essentially, sustained robust US real gross domestic product (GDP) growth has allowed the Fed to keep policy rates higher for longer to meet its dual mandate of price stability and maximum employment. In its Summary of Economic Projections (SEP), the Fed lifted its US GDP 4Q23 YoY growth forecast dramatically to 2.1% (from 1%) and outlined a lower unemployment rate through 2025 than it did in June.
As such, this latest round of central bank action has led to continued strength in the US dollar, firmer yields across the board and weaker equities. At the heart of this latest round of market jitters is the worry that with policymakers moving away from the debate about how high to raise rates to how long rates will remain at these restrictive levels, interest rates will likely remain higher for longer than the market previously envisaged. Indeed, financial markets appear to have taken particular note of the upward revisions to the FOMC’s dot plot next year, which now only envisages 50 bps of cuts over 2024 vs the 100 bps of cuts envisaged in June. This means that the Fed itself has reassessed the prospects for cuts next year, with December 2024 Fed funds futures selling off to imply c. 75 bps of cuts – 25bps less than previously anticipated.
The bottom line
Overall, there appears to be an increasing view amongst monetary policymakers that the time has come to sit back and allow previous tightening to work through the economy. With activity slowing notably in the eurozone (EZ) and the UK and inflationary pressures easing, the need for the BoE and European Central Bank (ECB) to pause seems greater than in the US, where output and employment growth remain surprisingly strong. However, despite the general growth concerns and easing price pressures, central bankers (even in the US) were at pains last week to stress that policy rates were likely to remain at a restrictive level that would dampen economic activity for some time. For all intents and purposes, this is a necessary evil to ensure that the disinflation process is sustained and that inflation timeously returns to targeted levels (2% in the US, the EZ and the UK; 4.5% in SA). To put it in simple terms, there does not appear to be any rush on the part of monetary policymakers in any of these regions to cut the policy rate. Indeed, markets have seemingly finally caught up to the higher-for-longer narrative – a reality many economists have warned about for some time.
A cautious SARB holds its breath as fuel prices start to reek
Unfortunately for local consumers (albeit matching expectations), SA’s August headline CPI print rose for the first time in five months to 4.8% YoY, from 4.7% YoY in July. Until now, the positive deceleration in headline inflation over the last few months has primarily been driven by strong base effects on fuel inflation, which, as anticipated, have now started to dissipate from the August data. Base effects in inflation data essentially occur when comparing prices in a specific year to the previous year – as commonly quoted. These effects can make inflation appear higher or lower than it actually is because it depends on the starting point (the “base” year). If the base year had unusually high or low prices (as witnessed throughout last year), it could distort the YoY inflation rate.
So, when interpreting inflation data, it is essential to consider how the choice of the base year can affect the perception of inflation. As such, these base effects and some of the fuel price increases we saw in August were largely responsible for the renewed increase in the latest inflation data. Indeed, Brent crude oil prices have sadly risen by over 25% since late June amid cuts in supply from major producers. Unfortunately, these factors offset further easing in food and non-alcoholic beverages (NAB) inflation (one of the biggest components of the CPI basket), softening from 9.9% YoY in July to 8.0% YoY in August. Except for fruit, all food and NAB categories recorded lower annual rates in August, which still assisted in taking some of the heat off the headline rate. However, this was not enough to counteract the rise in fuel prices and increases in municipal tariffs. Looking ahead, we largely expect another spike in the September inflation data, supported by more sizeable increases in fuel prices. It should then drift sideways in the top part of the inflation-target band until around mid-2024 when it is likely to get closer to the mid-point of the target range on a more sustained basis – cue a sigh of relief for consumers.
With this in mind, as expected, the SARB looked through the first-round inflation impact of these supply-side shocks last week and kept the repo rate on hold at 8.25%, with the prime rate remaining at 11.75%. As expected, the material retreat in inflation expectations in the Bureau of Economic Research’s (BER) 3Q23 survey (released the week before) largely negated the renewed inflation risks from the latest currency slippage and increased global fuel and food prices. Nonetheless, it is important to note that the latest jump in global oil prices remains a notable risk to the short- to medium-term inflation trajectory (as is the recent rand weakness), with the SARB still cautioning that it might tighten policy further if supported by data developments, i.e., further unfortunate fuel piece rises.
The bottom line
Since the MPC’s last meeting, near-term prospects for the global economy have been broadly unchanged. Whilst global inflation has broadly eased over the year, any further slowdown is beginning to look less certain. Closer to home, loadshedding continues to hamper the economy, and prices for commodity exports continue to weaken. In the near term, stronger El Niño conditions threaten the agricultural outlook, while global climatic events present additional risks. Energy and logistical constraints remain binding on the growth outlook, limiting economic activity and increasing costs. As such, the renewed upside risks from rand weakness and higher global fuel and food prices will likely keep the possibility of modest further tightening alive in the last MPC meeting for the year, which will be held in November.
A Game of (energy) Thrones: Coal still reigns supreme
Electricity generation is at the heart of our modern way of life. As the world grapples with the challenges of climate change and seeks to provide access to reliable and sustainable energy, the global energy landscape continues to evolve. The transition to cleaner, more efficient, interconnected systems ensures a brighter, more sustainable energy future for all. Last year saw 29,165.2 TWh of electricity generated worldwide – a 2.3% YoY increase. Shockingly, however (pun fully intended), coal still leads the charge when it comes to electricity, representing 35.4% of global power generation in 2022, followed by natural gas at 22.7% and hydroelectric at 14.9%. Over three-quarters of the world’s total coal-generated electricity is consumed in just three countries. Unsurprisingly, China is the top coal user, accounting for 53.3% of global demand, followed by India at 13.6% and the US at 8.9%. Unfortunately, burning coal (for electricity, metallurgy, and cement production) remains the world’s largest source of CO2 emissions. Yet, its use in electricity generation has grown 91.2% since 1997, when the first global climate agreement was signed in Kyoto, Japan.
Whilst coal has been a dominant source of electricity generation in the past, its continued domination in the world energy landscape can be attributed to several factors. These include:
- Abundant coal reserves: Many countries have significant domestic coal reserves, making coal a readily available and relatively inexpensive energy source. This is particularly true in regions like the US, China, India, and Australia.
- Existing infrastructure: In some areas, extensive coal-fired power plant infrastructure already exists. Replacing or retrofitting these facilities with alternative energy sources can be costly and time-consuming, deterring transition efforts.
- Energy security: Coal can provide energy security for countries concerned about relying too heavily on imported energy sources. Using domestic coal resources can reduce vulnerability to energy supply disruptions.
- Steady energy supply: Coal-fired power plants are known for providing a stable and consistent supply of electricity, which is essential for meeting baseload power demand. Some argue that renewable energy sources like wind and solar can be intermittent, requiring backup power sources.
- Job creation: The coal industry supports mining, transportation, and power-generation jobs. Transitioning away from coal can have economic implications, including job losses in regions heavily dependent on the coal industry.
- Political and regulatory factors: In some regions, political and regulatory factors play a role in the continued use of coal. Governments may have historical ties to the coal industry or face resistance when transitioning to cleaner energy sources.
- Economic considerations: In certain situations, coal can be the cheapest option for electricity generation, primarily when environmental and social externalities are not fully accounted for in the cost of coal-fired power.
However, even as non-renewables continue to reign supreme in the global energy landscape, their days are slowly numbered. In 2022, renewables (such as wind, solar, and geothermal) represented 14.4% of total electricity generation, with an extraordinary annual growth rate of 14.7% – driven by significant gains in solar and wind. Non-renewables, by contrast, only managed a rather lacklustre growth rate of 0.4%. Nuclear energy was another big loser in the energy game last year. In addition to disruptions at the Zaporizhzhia Nuclear Power Plant in Ukraine, shutdowns in France’s nuclear fleet to address corrosion found in the safety injection systems of four reactors led to a 4% YoY drop in global use. That country’s electricity generated by nuclear energy dropped by 22% to 294.7 TWh in 2022. As a result, France was dethroned from being the world’s biggest electricity exporter to a net importer.
The bottom line
Transforming mechanical energy into electrical energy follows a relatively simple procedure. While modern power plants represent remarkable engineering feats, their underlying principle sadly remains consistent with Michael Faraday’s inaugural generator design from 1831. However, the complexity arises in determining the source of the mechanical energy. Initially, coal fueled the inaugural industrial revolution but carried adverse environmental consequences. Wind energy offers a clean and cost-effective solution, yet its reliability can be inconsistent. Conversely, nuclear fusion consistently produces emissions-free electricity but raises concerns regarding radioactive waste disposal. With temperatures and adverse weather patterns hitting new records worldwide, resolving these tensions is not just an academic or political game of (energy) thrones but also imperative for the world’s economic and climate future.
