The SA Reserve Bank opted to leave the Repo rate unchanged yesterday at 5.50%. This was in-line with the market consensus, although 4 out of the 23 analyst surveyed had expected a further rate reduction (STANLIB was looking for rates to remain unchanged). The Reserve Bank last adjusted interest rates a year-ago, when they cut rates by 50bps. The prime interest remains unchanged today at 9%, which is the lowest prime rate for a number of decades.
In making the decision to leave rates unchanged, the Reserve Bank highlighted the following:
Inflation:
- Inflation appears to have peaked in many of the advanced economies, and is expected to moderate.
- Inflationary pressures remain at elevated levels in many of the major emerging market economies.
- Exogenous supply side factors have resulted in a deterioration of SA’s inflation outlook, with a more protracted breach of the inflation target expected in 2012.
- Food prices continue to pose an upside risk to the inflation outlook, and a further acceleration of food inflation is expected in the near term.
- The inflation forecast of the Bank showed a modest increase since the previous meeting of the MPC.
- Inflation is expected to breach the upper end of the target range in the final quarter of 2011 and to peak in the first quarter of 2012 at around 6,3 per cent before declining gradually and returning to within the target range in the final quarter of 2012.
- The bank is concerned that the change in the profile of the inflation forecasts, and the extended breach of the upper end of the inflation target range, may impact adversely on inflation expectations.
- The risk to the inflation outlook is to the upside mainly due to cost push pressures.
Growth:
- The global growth outlook continues to be characterised by heightened uncertainty with weak growth and declining consumer confidence in a number of the major advanced economies.
- Growth in many of the emerging markets has moderated during the year. China has experienced a policy-induced slowdown, but fears of a possible hard landing have receded somewhat.
- The composite leading business cycle index of the Bank continued the moderate downward trend that began in February. It decreased for the second consecutive month in August, corroborating the expected restrained economic conditions.
- The slower domestic economic growth in the second quarter of 2011 appears to have continued in the third quarter and the forecast of the Bank has been subject to downward revision.
- Real GDP growth in 2011 is now expected to average 3,0 per cent, compared with 3,2 per cent in the previous forecast.
- The growth forecasts for 2012 and 2013 have been revised down to 3,2 per cent and 4,2 per cent from 3,6 per cent and 4,4 per cent respectively.
Overall, the Reserve Bank is clearly trying to balance the competing demands of managing the inflation outlook, while at the same time doing enough to stimulate the economy.
The current level of interest rates is stimulatory. Furthermore, the level of domestic interest is not the main factor inhibiting economic growth. Rather, the relatively subdued domestic economic conditions are partly a function of the weak global economic environment as well as a lack of domestic fixed investment activity and job creation. Reducing the cost of capital (interest rates) is only one factor impacting the investment and hiring decision. Instead, other policy initiatives are required to stimulate SA’s growth rate. The burden of encouraging higher economic activity cannot fall perpetually on the Reserve Bank – especially given their mandate to keep inflation inside the target range.
While the Reserve Bank beliefs that SA’s inflation rate will ultimately move back inside the target range during 2012 (assuming inflation rises above the target range in late 2011/early 2012), there is no doubt that a combination of lowering interest rates (assuming the Bank had cut rates today) and the inflation rate breaching the upper-end of the target range later this year or early next year could significantly raise inflation expectations. That could then make achieving the inflation target in late 2012 or early 2013 a difficult task.
While there is still an opportunity for the Reserve Bank to cut rates in 2012, that would require a noticeable change in the current inflation and/or growth outlook. In other words, a further cut in rates would only be justified if SA’s growth dynamic were to deteriorate significantly, and/or if the inflation rate were to moderate significantly.
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