The South African Reserve Bank (SARB) is likely to begin lowering interest rates much earlier than previously expected and the urgency for a cut already at the next Monetary Policy Committee meeting on 11 December is building, according to Rian le Roux, chief economist at Old Mutual Investment Group (SA) (OMIGSA).
Le Roux says the SARB is likely to begin lowering interest rates in February 2009, rather than during the second quarter as expected before, and there is even a strong chance (nearly 50%) of a 50bp rate cut in December. The chance of earlier rate cuts has increased substantially following two crucial economic developments: the notably sharper-than-expected weakening of the real economy and a further improvement in the inflation outlook.
“By almost every measure, the real economy is now in a downswing,” he notes. “Real retail sales, building plans passed, car and commercial vehicle sales, cement sales, mining production and manufacturing production – all are in negative territory. Consumer and corporate credit growth, meanwhile, have fallen sharply since the beginning of the year.”
As a result of this sharp slowdown, le Roux says that South Africa’s third quarter GDP growth could well be negative, i.e. a contraction in overall economic activity. Such an outcome will clearly demonstrate how suddenly the economy has hit a brick wall, as the second quarter’s growth pace was still 5%. This will be the first quarterly contraction in the economy since the third quarter of 1998, when the Asian crisis hit the local economy.
While both current conditions and the outlook for the economy have clearly deteriorated, one should also guard against over-pessimism, he cautions. While some parts of the economy are already experiencing severe recessionary conditions, there are some elements of good news, too. Importantly, the government’s infrastructure programme will lend ongoing solid support to the economy, and financially battered consumers can also look forward to relief in coming months. The petrol price has already declined sharply and is set to fall further, inflation will ease sharply over the next year, some tax relief is likely in the Budget in February and interest rate relief should be forthcoming during 2009.
Consequently, he has revised his growth forecast for all of 2008 to 3.3% from 3.5% previously and for 2009 to 2.0%, from little under 3.0% previously. However, with global conditions deteriorating rapidly, the risk to these forecasts are to the downside.
Meanwhile, there has been a further improvement in the inflation outlook in recent weeks due to global factors, as well as the intensifying local slowdown, le Roux explains. The peak in CPIX inflation was confirmed at 13.6% y/y in August, falling to 13.0% y/y in September. Despite the weaker rand, the oil price in rand terms has fallen further and was by mid-November back at mid-2007 levels. “The petrol price is set for another sharp decline at the beginning of December,” he adds. “Moreover, food inflation has also started to ease at the producer level and this will in due course be reflected at the consumer level, too.”
On top of this, the deflationary impact of recessions in many of the world’s largest economies will also impact on SA, as the prices of many internationally tradable goods are declining, owing to tough competition and growing excess capacity globally. Le Roux is now expecting CPIX to fall to 10.7% y/y in December, and to drop rapidly from early 2009, ending the year at around 5.5% y/y and averaging 5.6% y/y for 2009 as a whole.
As for OMIGSA’s interest rate view, le Roux says: “With global interest rates falling sharply, our own inflation outlook having improved further and the economy slowing very sharply, we have moved forward our base case forecast for interest rates to a 50bp cut in February rather than April. However, the probability of a December rate cut is increasing on the back of the rapid deterioration in economic conditions. The argument in December for the SARB should be ‘why should we not cut’, rather than ‘why should we cut’. So, while a December cut is still by no means a certainty, it should be seriously considered given the weakness in the economy and the fact that interest rate changes work with long lags.”
Looking further out, notes le Roux, even if the Bank was to cut rates in December, the SARB is likely to ease policy cautiously through 2009 as underlying inflation pressures remain troubling and the risk of renewed rand weakness remains high. “Further weakness in the rand – the main risk in the current economic climate - would jeopardise the positive inflation outlook and delay further interest rate cuts,” he concludes.
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