Tim­ing a cut

Some say Fe­bru­ary, oth­ers April next year

Finweek English Edition - - Economic Trends & Analysis - GRETA STEYN gre­tas@fin­week.co.za

THE FACT THERE WAS spec­u­la­tion be­fore the last SA Re­serve Bank mon­e­tary pol­icy com­mit­tee (MPC) meet­ing that it would cut rates is a sign of how bad the global fi­nan­cial credit cri­sis be­came. The rate cut didn’t hap­pen. But some economists have moved up their rate cut fore­casts to Fe­bru­ary next year.

On 8 Oc­to­ber, six cen­tral banks – led by the United States Fed­eral Re­serve – cut their in­ter­est rates by half a per­cent­age point. At the time, fi­nan­cial mar­kets, in­clud­ing in SA, were in a melt­down. The no­table ex­cep­tion was the bond mar­ket, which was ral­ly­ing on the be­lief Bank Gov­er­nor Tito Mboweni would fol­low his in­ter­na­tional coun­ter­parts with a cut.

But the sit­u­a­tion in SA is very dif­fer­ent to that in the six coun­tries that did cut rates. First, SA’s fi­nan­cial ser­vices sec­tor is healthy. Sec­ond, the coun­try isn’t head­ing for re­ces­sion, al­though growth will slow dra­mat­i­cally. Third, the in­ter­na­tional cri­sis put down­ward pres­sure on the rand, rais­ing inflation risks.

Economists ar­gue inflation risks will start to re­cede next year, partly re­flect­ing the re­bas­ing of the inflation base year and reweight­ing of the con­sumer price in­dex (CPI) bas­ket. Some be­lieve the Bank will want to wait un­til a down­ward trend in inflation is es­tab­lished, and that the ear­li­est that a cut could take place is in April. But oth­ers see Fe­bru­ary as a pos­si­bil­ity.

Mer­rill Lynch econ­o­mist Car­men Nel says the Re­serve Bank is fac­ing a trade-off be­tween the po­ten­tial im­pact of the global cri­sis on SA’s econ­omy and the need to pro­vide for­eign in­vestors with a high yield. “Global volatil­ity war­rants real com­pen­sa­tion for risk,” she says, pre­dict­ing the Bank will keep the repo rate un­changed “at the very least for the rest of this year”.

Nel says the ar­gu­ment for rate cuts next year, start­ing in Fe­bru­ary, is “quite me­chan­i­cal”. Lower inflation (partly on tech­ni­cal grounds) al­lows for pol­icy eas­ing, which in turn is ex­pected to trig­ger a growth re­bound. “Stronger gross do­mes­tic prod­uct growth will re­sult in ris­ing earn­ings ex­pec­ta­tions and thus make the eq­uity mar­ket more at­trac­tive to for­eign in­vestors. That would then be ad­e­quate to fund the cur­rent ac­count deficit.”

A more en­thu­si­as­tic pro­po­nent of rate cuts start­ing in Fe­bru­ary is Rand Mer­chant Bank’s Et­ti­enne le Roux, who pre­vi­ously had thought the first cut would only come in June 2008. Le Roux notes com­mod­ity prices have fallen sharply, with the slump in the oil price tak­ing him by sur­prise. Though con­cerns about ser­vices inflation re­main (par­tic­u­larly rentals and wages) the prospects for goods inflation have im­proved enough to jus­tify RMB low­er­ing its inflation fore­cast – de­spite the weaker rand.

RMB now ex­pects the CPI rate – which is ex­pected to re­place CPIX as the tar­geted mea­sure of inflation from next year – to fall within the tar­get band in April 2010. Pre­vi­ously, Le Roux had thought that wouldn’t have been pos­si­ble be­fore June 2010.

“Against that back­drop we now ex­pect the MPC to start cut­ting four months ear­lier than pre­vi­ously thought (Fe­bru­ary 2009 in­stead of June). We’ve also added an ad­di­tional 50 ba­sis points to the cy­cle (250 ba­sis points against 200 ba­sis points pre­vi­ously).”

Le Roux says the risk of a rate cut in De­cem­ber is in­creas­ing but says that’s too op­ti­mistic. At the time of its De­cem­ber meet­ing, the MPC will have inflation data for Novem­ber, which will still be around 12,6%. “Al­though on a de­clin­ing trend, such a high num­ber will make it dif­fi­cult for the Bank to cut.”

Le Roux is also not con­vinced the MPC will loosen pol­icy be­fore know­ing the ex­act im­pact of the re-weight­ing of the bas­ket on the inflation rate. “That’s such a sig­nif­i­cant

“The reweight­ing of the CPI bas­ket is a ma­jor event.”

event (with huge un­cer­tainty at­tached to it) that we doubt the Bank will cut be­fore the out­come is known in Fe­bru­ary.”

Le Roux adds that, al­though do­mes­tic growth is mod­er­at­ing, the sever­ity of the slow­down in SA is nowhere near what de­vel­oped coun­tries are cur­rently ex­pe­ri­enc­ing. Also, ma­jor cen­tral banks are cut­ting rates in an at­tempt to lessen the ef­fect on their real economies of an acute liq­uid­ity crunch in their coun­tries, which isn’t ap­pli­ca­ble to SA.

Stan­dard Bank econ­o­mist Danelee van Dyk says the Re­serve Bank’s fo­cus on inflation will make it im­pos­si­ble for it to cut rates be­fore April next year. “The Bank will main­tain its in­fla­tion­ary view as the pri­mary rea­son to de­lay rate cuts. SA is rel­a­tively well in­su­lated from the global fi­nan­cial cri­sis,” she says. Stan­dard Bank ex­pects 50 ba­sis point cuts in April, June, Au­gust and Oc­to­ber next year.

Ned­bank’s economists say they ex­pect the first rate cut to come in April, when there will be clear ev­i­dence of a down­ward trend in inflation. They de­scribe the tone of the last MPC state­ment as “dovish”.

Inflation will be be­low tar­get by April 2010. Et­ti­enne le Roux

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