We welcome the South African Reserve Bank (SARB)’s decision to lower interest rates by 100 basis points (bps) today, as well as the Monetary Policy Committee (MPC)’s earlier decision to hold monthly meetings in the current uncertain global economic environment.
Today’s rate cut, which was widely expected, should help counteract the sharp slowdown being experienced in the local economy, particularly in the mining and manufacturing sectors, as well as in consumer- and private investment spending, and help to partially offset the effect of the recent tightening in lending standards by local banks.
Had the SARB not acted today, but waited until its regularly scheduled meeting in April to cut rates, it could have risked having monetary policy “behind the curve” in relation to the current economic down cycle. This could have resulted in the need for very steep interest rate cuts at a later stage, thus making worse the magnitude of swings in the cycle.
As it is, the 100bp reduction in rates should help restore consumer confidence and boost household disposable incomes, while also bringing some relief to indebted businesses. It should also provide a boost for the equity market by helping improve prospects for corporate earnings sooner rather than later in the year.
We expect a further reduction in interest rates over the remainder of the year and given the downside risks to the real economy, the further lowering of rates will likely be ‘front-loaded’ over the next few MPC meetings. However, we expect the SARB to pause with its easing cycle later in the year in order to assess the impact of previous rate reductions and also because the local inflation outlook is not as rosy as in other parts of the world. At this stage, and provided no further external shocks occur, we expect rates to be lowered by a further cumulative 200 basis points over the remainder of the year.
We expect the targeted CPI to remain around the 7-8% y/y level over the next few months, before briefly falling into the SARB’s 3-6% y/y target range by mid-year. Base effects and administered price increases are expected to drive it out of the range again later in the year. As a result, we expect the SARB to pause with its easing cycle some time during the second half of the year in order to assess the growth/inflation environment and to give policy changes time to work through the real economy.
Given the severity of the global downturn and the sharp decline in the local economy in recent months, we have recently downgraded our forecasts for South Africa’s GDP growth in 2009 to virtually zero, with risks still skewed to the downside. Available data point to a further contraction in GDP during the first quarter of 2009. We expect the economy to remain depressed during the middle quarters of the year, with a moderate recovery taking hold towards the end of 2009.
The major uncertainties remain the severity and length of the global downturn, as well as the large current account deficit and investor risk appetite. Any renewed weakness in the rand risks exacerbating inflation and putting the SARB’s interest rate easing phase on hold.
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