Another nail in the rate cut coffin
Last week Thursday – 24 July 2010 – the Monetary Policy Committee (MPC) of the South African Reserve Bank (SARB) announced ‘no change’ to the repurchase rate, leaving it at 6.5% per annum. “The announcement [was] consistent with market expectations, even though a few economists had suggested there [was] room for another interest rate cut,” said Sheshi Kaniki, senior economist at Momentum. StanLib says seven out of the 26 analyst (themselves excluded) had expected a further rate reduction!
The decision was undoubtedly influenced by ongoing concerns over the strength of economic activity (both locally and abroad) and the impact of rising unemployment at home. Local interest rates rise and fall in cycles, largely based on expectations for domestic consumer price inflation. In this regard, we have to turn to the MPC’s most recent motivation: “Inflation is expected to remain within the inflation target range until the end of the forecast period, which is end of 2012, helped by a benign global inflation environment,” they said. “BUT despite the persistent moderation of inflation, inflation expectations have remained relatively high!”
A quick study of interest rate charts suggests hopes for another cut are misplaced. At just 10% the prime mortgage rate is at its lowest level since January 1981! At this level, concerns over inflation will overshadow the slower than expected economic recovery. Besides – consumers have already benefited from a 550 basis point fall since the previous cycle peak at 15.5% in December 2008.
The savings versus interest rate debate
July is National Savings Month and the MPC used the opportunity to remind ordinary South Africans of the importance of saving. The question on many ordinary citizens’ lips though is whether the SARB is doing enough to assist with this important goal. “One of the most important contributions of monetary policy with regards to savings is to foster an environment of macroeconomic stability by keeping inflation low,” observed Kaniki. The central bank achieved this objective mid-2009, when inflation finally fell within its 3% to 6% target band.
Unfortunately this stable economy wreaks havoc with savings due to lower interest on cash. Kaniki pointed out the obvious: “Lower interest rates mean that savers get a lower return on their savings – an apparent deterrent to saving…” The trick is to consider the real (after inflation) effect on your cash investments and to understand that this return can improve even if interest rates remain unchanged. So, for example, if you receive 6.5% per annum on your money with CPI at 6%, your real return is 0.5% per annum; if interest rates remain unchanged and CPI drops to 5.5% your real return doubles to 1%.
The MPC has to consider businesses and individuals when setting interest rates. Real returns on cash savings are already negative, so another cut in bank cut rates would have caused terrible hardship for the thousands of South Africans who rely on investment income for survival. Because the sensible decision would have been to hike rates, assistance to business actually derives from the decision to leave rates unchanged.
Drowning in debt
Gill Marcus, recently appointed governor of the Reserve Bank, added her voice to the savings debate recently. She told I-Net Bridge that the country’s debt levels were far too high for its emerging economy status. The national saving rate expressed as a percentage of GDP hovers around 15%, while China and India boast numbers in excess of 35%. To make matters worse, local household debt to annual income stood at 78.4% at the end of March 2010, with as much as 8% of disposable income being gobbled up by interest on loans. International economic ‘think tanks’ agree with Marcus: “The OECD Economic Survey of South Africa released last week identified a higher saving rate as essential if South Africa is to achieve higher growth,” commented Kaniki. Higher growth is the only way the country will generate much needed jobs.
The next interest rate decision will be taken in September 2010. Kevin Lings, economist at StanLib, says “we should expect the bank to keep rates on hold for the remainder of 2010 and well into 2011.” He expects a close call at the next meeting, but remains in the ‘next interest rate move is higher’ camp. Hike or cut, the attitude of the average South African towards saving will remain unchanged.
Editor’s thoughts: Today’s newsletter contains an interesting lesson on human behaviour – the tendency to always reach for the largest slice of cake. Instead of obsessing over your nominal cash return you should remain focussed on the real return. Assuming the CPI measure is accurate – the subject for another debate – your real interest can improve even if the repurchase rate remains unchanged. Do you expect another interest rate cut in 2010, or are you already saving up for the next hike in 2011? Add your comment below, or send it to [email protected]
