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Another rate cut – it all depends

14 August 2009 Advantage Asset Managers

Sonja Saunderson, deputy chief investment officer at Advantage Asset Managers says that that SA Reserve Bank governor Tito Mboweni surprised markets by announcing a 50 basis point interest rate cut, saying that despite cost pressures, the adverse economic conditions were likely to keep inflation on a downward trajectory, which justified a cut in rates. Bond yields hinted at this outcome when they rallied after the release of the retail sales figures on 12 August.

Statistics South Africa revealed that domestic retail sales had fallen 6.7% year-on-year in June 2009 reflecting that consumers remained under significant pressure. The retail sales numbers came in after a slew of negative data that continue to point an economy in recession. A contraction in excess of 6% (as seen in the first quarter of the year) is unlikely to be seen but the contraction will be significant.

This notion comes from vehicles sales falling (albeit at a slower rate) by 25%, mining production falling a further 7% and manufacturing production falling a staggering 17%.

Manufacturing makes up 15% of the gross domestic product (GDP) and this has fallen to unprecedented levels. Statistics South Africa highlights that the 17% decrease in manufacturing production was mainly due to lower production in the basic iron and steel, non-ferrous metal products, metal products and machinery division, followed by motor vehicles, parts and accessories and other transport equipment and the petroleum, chemical products, rubber and plastic products division

Falling production due to anemic demand has led to widespread job losses. Statistics South Africa has recently reported that over the first six months of the year, close to 500 000 jobs have been shed.

Given the poor state of the economy, an interest rate cut is a welcome relief. The Bank continues to believe that inflation will ease to within the target band (3-6%) by the second quarter of 2010. The inflation rate currently stands at 6.9%. The Monetary Policy Committee (MPC) stated a number of the risks pertaining to their benign inflation outlook. These include international oil prices, administered prices (particularly electricity prices) as well as wage increases.

Oil prices have climbed in excess of 90% in 2009, having started the year off at $37 per barrel, Brent crude is now trading a $73 per barrel. High oil prices filter through to higher petrol prices which by and large adversely affect the economy; from the disposable income of consumers to distributors at all levels.

Strike action and double-digit wage demands are also playing a role in fuelling inflation, with wage settlements in the first six months of 2009 averaged 9.7%.

Globally, major central banks seem to have come to the end of their rate cutting cycles. In the Euro zone, second quarter GDP has surprised on the upside reporting a contraction of only 0.1% with Germany and France reporting growth of 0.3%.

The US Federal Reserve has also recently stated that they believe that the worst is behind them and that the downturn appeared to have bottomed. It is likely that the MPC will also remain on hold looking out for ‘green shoots’ within our economy. If these materialise, this interest rate cut may well have been the last one of this cycle.

Most of the fixed interest fund managers used by Advantage Asset Managers weren’t expecting a rate cut, despite recent growth figures disappointing on the downside. This was largely based on the assumption that, while growth remained weak, this was to be expected given the usual lag between rates and economic activity, and the outlook for inflation remains unflattering. Most fund managers believe this is to be the last interest rate cut in the cycle, but much will depend on future economic data.

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