Hold thumbs for another interest rate cut
Is there a link between growth, inflation and interest rates? Given enough time you could structure a thesis on the interplay between these measures. Some will argue growth and inflation cannot exist separately – others that interest rates determine growth – and no two views will be the same. South Africa’s central bank has been criticised for ignoring growth concerns and sticking to its inflation targeting policies through recession. Analysts believed aggressive interest rate cuts would revitalise the hard-pressed consumer and boost the faltering economy.
Their apprehension might have been misplaced. The reason is the bank cut interest rates by 500 basis points between December 2008 and August last year. The central bank did exactly what these analysts advocated, cutting interest rates aggressively both before and after Statistics SA confirmed the country’s technical recession. As a result South Africa’s GDP growth rate returned to positive territory in the final two quarters of that year. The problem: this growth is off a low base and comes against a backdrop of soaring unemployment. It’s little wonder the trade unions want the central bank to intervene more in the economy.
A new inflation strategy
Trade union demands and calls from various sectors to ‘nationalise’ the Reserve Bank must have haunted finance minister Pravin Gordhan as he penned his 2010 budget speech. The minister had to balance the interests of the overall economy with the demands from the left to abolish inflation targeting. Gordhan quoted from Section 224 (1) of the Constitution as his starting point: “The primary objective of the South African Reserve Bank is to protect the value of the currency in the interest of balanced and sustainable economic growth in the Republic.” Gordhan said the bank should pursue this mandate independently and without fear, favour or prejudice. But he wasn’t afraid to mix things up a bit.
“The global financial crisis has illustrated the need for central banks to take a broader view of the economy in managing inflation; including growth, employment trends, asset prices, financial sector stability and competitiveness of the exchange rate,” he said. Investment solutions economist, Chris Hart, believes Gordhan’s speech could signal a significant change in central bank behaviour. “At the end of the day [the budget] was highly significant in the sense that employment and growth are now expected outcomes of monetary policy,” said Hart. In other words, the Reserve Bank could deviate from its inflation target in response to economic shocks. Hart says this ‘change’ could benefit consumers by way of one or two unexpected interest rate cuts in 2010.
Addressing union concerns
Gordhan went out of his way to address union concerns. He noted that a credible monetary policy framework focused on managing inflation was crucial to reducing long term borrowing costs and providing confidence about the future. “Monetary policy is necessary to stimulate investment, employment and competitiveness – particularly among exporters and import-competing industries,” said Gordhan. He also stressed that low and stable inflation was essential to protect the living standards of workers and the poor!
Growth could get in the way
One of the popular arguments in support of further interest rate cuts is the poor state of the domestic economy. Interest rate cuts can be used to stimulate consumer activity, thereby boosting overall economic activity. Trade union organisations believe they can create jobs by simply cutting rates. Unfortunately it’s not that simple. A prudent central bank strategy is aimed at smoothing the business cycle over time. The latest macroeconomic measures suggest that interest rate cuts since December 2008 have finally filtered to the economy. How do we measure this improvement?
A good proxy for the state of the economy is the South Africa leading economic indicator, compiled by the Reserve Bank from 13 sub-indicators. The indicator improved in December 2009. “This is the fifth consecutive monthly rise in the leading indicator, which pushed the annual rate of change to an impressive 13.1% year-on-year, compared with 10.7% in November and 5.0% in October,” said Kevin Lings, economist at Stanlib. He expects annualized quarter-on-quarter growth for Q4 2009 to equal market consensus of around 3%. And that should create enough momentum to lift 2010 GDP to between 2.3% and 3%.
Editor’s thoughts: With looming electricity price hikes – details will be announced on Wednesday – the consumer is going to need all the help they can get. We couldn’t help wondering whether an interest rate cut would offset hikes in administered prices… Do you expect a couple more interest rate cuts through 2010? Add your comments below, or send them to [email protected]
Comments