GDP growth recovery set to continue, but the outlook is “unusually uncertain”

The SA economic recovery continued to strengthen during 2010Q1 with growth of 4.6% q-o-q (annualized) recorded. More up to date figures - especially for the manufacturing sector - have been less upbeat, hinting that the Q1 pace of growth is unlikely to be sustained. Looking forward, and as highlighted in the July statement from the central bank’s Monetary Policy Committee, the global economy continues to present the biggest downside risk to SA growth.

The world economic recovery, which continued to strengthen in the first quarter of 2010, faced some significant headwinds during 2010Q2. Most concerning was the revelation that public finances in a number of (mainly) southern-European countries such as Greece were much worse than previously thought. The dire European fiscal dynamics raised fears of debt default(s) and importantly contagion to banks in larger European economies such as Germany and France that hold most of the periphery country debt. As a result of the increased uncertainty, world stock markets declined sharply in Q2 (compared to Q1) with the MSCI global equity index down more than 13%. SA financial markets, including the equity and currency (versus the US dollar) markets were also adversely affected.

A second global development (although not universal) is that recent economic data in countries such as the US reveal a soft patch in growth momentum. There are a number of risks that may result in a further growth moderation, especially in developed countries. Most industrialized countries have announced fiscal austerity measures aimed at lowering high public debt levels, the impact of which should be negative for growth. The risks are also reflected in the IMF’s latest global growth forecast, released early July. While the global lender increased its 2010 global growth forecast from 4.2% in April to 4.6%, the projection for 2011 remained unchanged at 4.3%. Importantly, growth in the regions most important for SA exports (Europe and China) was adjusted lower (by 0.2 and 0.3 percentage points respectively) for 2011. The expectation of weaker global growth in 2011 has informed the BER’s view that there is limited further upside potential for commodity prices such as oil and copper.

Despite the robust 2010Q1 growth performance, the SA economy has still not recovered all the ground lost during the recession. Between 2008Q3 and 2009Q2, real GDP declined by 2.6% - from the low in 2009Q2 to 2010Q1, GDP increased by 2.3%. A positive development in Q1 was that consumer spending staged a strong comeback, increasing by 5.7% q-o-q. The better than expected Q1 consumption data has resulted in an upward adjustment to our overall household consumption forecast. Overall consumer outlays in real terms are now expected to increase by 2.5% (previous 2.1%) in 2010. The projection for consumer spending in 2011 was kept largely unchanged at 3.6%. The further improvement in 2011 reflects sustained strong growth in personal disposable income (PDI). 2

Whereas in 2010 PDI growth is set to be driven by robust real wage growth, a projected improved employment outlook (+1.8%) provides the impetus during 2011.

While we are more upbeat (compared to the previous forecast in April) about the consumer outlook, exports turned out significantly weaker than expected in Q1. Combined with the uncertainties surrounding global growth, the result is that net exports are now expected to subtract more from 2010 growth than previously thought. For 2010 as a whole, we have made a downward adjustment (from 3.4% in April to 3.1%) in the GDP growth forecast. Regarding 2011, the GDP growth forecast was kept largely unchanged at 3.3%. Two-thirds of the 2010 growth is forecast to be the result of an end to the huge inventory decline witnessed during 2009. "One of the implications of this growth mix is that the underlying conditions in the economy may remain weaker than what would normally be characteristic of a 3.1% real GDP growth environment", said BER senior economist Hugo Pienaar. As a result, no job growth is forecast for 2010.

While this year’s growth will be boosted by some technical factors, the forecast for 2011 is based on the view that the more normal drivers of SA growth (personal consumption, investment, net exports etc) will once again play a bigger part. However, with the inventory boost less than half the 2010 figure, the growth in gross domestic expenditure (the broadest measure of domestic spending) is expected to ease to 4% in 2011 from 4.7%. The 2011 GDP growth acceleration stems mainly from a smaller negative net export contribution – given the uncertain global outlook, there is a risk that this may not materialize.

The latest official data on the inflation front confirmed that consumer prices (CPI) remain on a downward trajectory. CPI eased to a new four-year low of 4.6% y-o-y in May from the 4.8% recorded during April. Both the May and April figures came in below market expectations. The BER remains with the view that while consumer inflation should remain contained for the rest of 2010 (CPI set to average 4.8%), price pressures may start to build in 2011 (averaging 5.7%). Our updated forecast suggests that CPI will reach a trough of 4% y-o-y in August 2010, before slowly starting to tick higher and ending 2011 just below the important 6% mark at 5.8%.

After reducing the repo rate by 550bps between December 2008 and March 2010, the central bank’s Monetary Policy Committee (MPC) kept the policy rate unchanged at 6.5% (the lowest level since the late 1970s) in May and July. With domestic inflation well within the inflation target band and recent mixed indicators on the global and SA growth front, SA financial markets remain optimistic about the possibility for another rate reduction at the September 9 MPC meeting. While a solid argument (benign inflation, continued currency strength and the uncertainty relating to the sustainability of global growth) can be made as justification for a further rate reduction, the BER’s baseline view remains for no further easing. Our interest rate call is informed by - as outlined above – an inflation forecast that sees CPI moving back towards the 6% target level in the second half of 2011. Given the forward looking nature of monetary policy, this leaves little room for a further downward rate adjustment. Of course to date the central bank has been more optimistic about future price prospects, expecting CPI to remain well below 6% through 2012. However, we are not alone in being more circumspect about the inflation outlook – the respondents to the BER’s 2010Q2 inflation expectations survey expect CPI to average 6.5% and 6.8% respectively during 2011 and 2012, i.e. significantly above the 3 to 6% inflation target.

On the GDP front, the central bank revised their 2010 GDP growth forecast up to 2.9% from 2.7% previously. As mentioned above, the data on consumer spending actually surprised on the upside in the first quarter of 2010. Regarding 2011, confirmation that the SA growth recovery is sustained, an improved (hopefully) global outlook and a projected build-up of SA price pressures should result in a contained move higher for the repo rate. At this stage, we remain with the view that the policy rate will be increased by 100bps during 2011. However, the timing of the first move higher has been shifted out from 2011Q1 to the third quarter as the SARB will want to be sure that the economy is on a more solid footing before starting to tighten monetary policy.

The rand averaged R7.54 against the US dollar in Q2, the third consecutive quarter that it has remained around the R7.50 mark. However, the impact of increased risk aversion following the European debt concerns can be seen in the monthly rand performance. After averaging R7.37/$ in April, the rand weakened to average above R7.60/$ during May and June. The local currency was not immune to global developments, but one may have expected more pronounced weakness. Although the rand should remain well supported for the time being, the BER remains with the view that a move to R8/$ and beyond is on the cards over the next 18 months. The forecast is informed by, amongst other things, increased risk aversion if global growth slows, muted further commodity price gains and sustained US dollar strength versus the Euro. As a result, the rand is expected to average R7.75/$ in 2010Q4, before weakening to average R8.45/$ in the final quarter of 2011. Against the Euro, the currency is forecast to remain firm and to average R9.72/€ in 2011Q4.