Be very, very, very careful

The SARB, as expected, left interest rates unchanged today, prime remaining at 10%.

It was an interesting message that was being conveyed by SARB Governor Marcus on behalf of the Monetary Policy Committee.

Basically things are going well in the economy.

Inflation has ticked lower, is expected to average 4.7% in 3Q2010 and is expected to remain within the 3%-6% target through 2012.

The growth recovery is continuing apace, with most growth forecasts revised higher, but not excessively so, with some areas of underperformance (jobs, credit, retail) remaining.

As a bottom line, both inflation and growth are expected to perform steadily.

However, when it came to risk, an entirely different picture presented itself.

It was again mentioned that public sector charging remains the main domestic threat to the inflation outlook. Mention was also made of the exceptional wage demands being made in places of late and should this continue, with no compensating productivity gains, this could ultimately prove challenging for the inflation outlook, something to be carefully watched.

By far the greater threat concentrating the Committee’s collective mind this past week, however, turned out to be the European situation, how a near contagion nearly started to run away last week, how this also rippled through our markets as global risk aversion reasserted itself, with the Rand rapidly reaching for 7.95:$ and the JSE nearly selling off 10%.

Quite clearly, such volatility is disconcerting, and shows the exposure of the country in the event of global disruptions and this giving rise to capital flow reversals. Such events, if truly taking hold, would pose a downside danger to output (growth), in a repeat of what was seen in late 2008, but also in terms of financial flows, with the Rand capable of rapidly losing ground, and thereby ultimately forming a major threat to financial stability, but also measured inflation.

These events, the awareness of the implied risks, the apparent deep uncertainty in the MPC as to where all these things still may lead in the months and years ahead, created a willingness to remain very sensible and rather do nothing policy-wise.

Clearly the country has reason, given experiences elsewhere, especially in Europe, to move very carefully in everything it does. Fiscal policy was highlighted as following a sensible trajectory and if continued it should not be a threat to monetary policy.

When in doubt, do nothing, and clearly the MPC wants to see where things go next globally, but especially in Europe with its many imbalances and sovereign debt issues.

Once the global skies clear, there will presumably again be less risk from this important source for the South African economy and there can be little doubt that the Committee by then will take a fresh look at things, including any major other risks facing the growth and inflation performances.

But for now we remain steadily on track within acceptable parameters while being highly aware of European happenings and ever so carefully monitoring those events to see how it will play for South Africa.

Until further notice, the SARB’s MPC remains on hold.