Timing a cut
Some say February, others April next year
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