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Inflation stability prompts change in interest rate prospects

18 July 2012 Nedbank Group

While the economic uncertainty that has characterised global markets in recent years is by no means a thing of the past, many markets, including South Africa, have recently seen a measure of stability returning to their inflation numbers.

According to Isaac Matshego, an Economist with Nedbank Group, this has had the effect of altering the country’s interest rate landscape and has caused many financial analysts and commentators, Nedbank included, to adjust their predictions around short-term interest rates for the foreseeable future.

“While South Africa’s inflation is still loitering around the upper end of the Reserve Bank’s 3% to 6% target bracket, the recent decline in the fuel price has quelled fears that it might break out significantly of the top end of this scale,” Matshego explains, “and this translates into a distinct likelihood that the Reserve Bank’s Monetary Policy Committee will leave interest rates unchanged for some time to come.”

Matshego goes on to say that with inflation under control, the possibility of further global economic woes resulting in a cut in the South African repo rate is now on everyone’s mind. However, he cautions against placing too much confidence in the likelihood of a cut anytime soon. He points out that while many commentators are calling on the Bank to follow the example of many other emerging economies by cutting rates, the situation in South Africa makes doing so somewhat difficult.

“The reality is that South Africa’s inflation rate of 6% and short-term interest rate of 9% leaves little scope for a significant rate reduction,” he explains, “not least because closing this gap creates the real risk of discouraging South Africans from saving – which is in direct opposition to government’s stated aim of growing a savings culture in the country.”

While he acknowledges that the Reserve Bank could address this concern by opting for a marginal reduction in the rate at the next MPC meeting, Matshego questions the viability of such an approach. “A 25 or 50 basis point reduction, while a potentially good public relations exercise, is unlikely to have any significant or sustainable impact on the country’s economy going forward,” he points out, “and with that being the case, there’s an increasing likelihood that this reduction would need to be reversed down the line, potentially putting many South Africans in an over-indebted position which could cause further economic woes.”

“Any rate cut decision taken by the MPC now simply must be a definitive one that demonstrates the Reserve Bank’s confidence in, and commitment to, its role in bolstering the country’s longer-term economic growth,” Matshego concludes, “anything less than that is likely to be viewed simply as tokenism by the market and I’m fairly convinced that this is not the message the MPC would want to convey at this delicate point - so unless inflation figures come down fairly dramatically in the near future, it’s still unlikely that consumers will benefit from an interest rate drop anytime soon.”

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