Economic conditions leave room for another rate cut
According to Statistics South Africa (Stats SA), year-on-year headline Consumer Price Index (CPI) inflation for March 2010 was 5.1 per cent, down from 5.7 per cent in February and 6.2 per cent in January. The inflation rate is now more comfortably within the target range of 3 – 6 per cent compared to when the Reserve Bank’s Monetary Policy Committee (MPC) reduced the repurchase rate (repo rate) by 50 basis points on March 25. The further easing in inflation leaves room for another interest rate cut when the MPC meets on Wednesday and Thursday.
Recent economic data released by Stats SA and the Reserve Bank suggests that the domestic economy is still fragile. Retail sales remain depressed, declining in real terms by 1.5 per cent year-on-year in both January and February. Credit, a major contributor to the economic boom prior to the recession, is yet to recover. Total credit extension declined by 0.32 per cent and 0.06 per cent year-on-year in February and March respectively. The unemployment rate in the first quarter of 2010 stood at 25.2 per cent, up from 24.3 per cent in the last quarter of 2009 and 1.7 percentage points higher than a year ago. A major contributor to the rise in unemployment was the loss of 140, 000 jobs in the formal sector since the last quarter of 2009. The alarming rise in unemployment is reflective of company liquidations which reached a monthly high of 410 in March 2010 compared to 347 in March 2009 and 297 in March 2008.
Given that South Africa is an emerging open economy, the MPC will also be taking into account the potential medium term impacts of external inflationary pressures. In its most recent World Economic Outlook, the International Monetary Fund (IMF), projects that CPI inflation in advanced economies will average 1.5 per cent in 2010 before dropping marginally to 1.4 per cent in 2011.
In emerging and developing economies CPI inflation is expected to average 6.2 per cent in 2010, falling to 4.7 per cent in 2011. These projections suggest that global inflation is supportive of domestic inflation remaining within the target range for the foreseeable future, providing the Reserve Bank with further room to reduce interest rates.
Economists were surprised when the MPC decided to cut the repo rate in March. CPI inflation falling within the target range, high levels of household debt and tight credit conditions contributed to this decision. Based on available data, economic conditions remain in favour of a rate cut this week. One development since March 25 that could be seen as unfavourable to a rate cut is the exchange rate which has weakened by about 2.6 per cent. However, the rand is extremely volatile and is unlikely to be a deciding factor. In her address to the Bureau of Economic Research Annual Conference on April 22, Governor Gill Marcus stated that the reduction in the repo rate in March was not informed by the value of the rand, explaining that in the past the rand’s response to interest rate changes has been unpredictable.
The weak recovery path suggests that any stimulus to the economy would be welcome by households and businesses. Domestic economic conditions and the global outlook for inflation allow the Reserve Bank to reduce interest rates further without compromising on its mandate to keep inflation within the target range of 3 – 6 per cent. Another rate cut could be less of a surprise than the last one.
