MPC Outlook on interest rates

The SARB’s last MPC of the year is currently underway and the decision will be made known on Thursday afternoon. There’s no doubt that these decisions are never easy but this one in particular seems more so than others. Once again the drama that is unfolding in Europe, which changes almost on an hourly basis, has to be at the back of the minds of MPC members. Europe matters because:

· It’s a major destination for our manufactured exports; this won’t be sustained if European growth falters and so demand for our goods dries up. A recession in Europe will also not be positive for commodity prices

· Should the crisis in Greece and the impending one in Italy not be resolved in a manner that reassures investors there’s a very real chance of this negatively impacting banks; a resulting contagion to the global economy and South Africa might not be dissimilar to what we saw a couple of years back

The tone of the previous MPC statement suggested that should the worst case scenario happen in Europe with either a government collapse or bank failure and the potential of the contagion looming over South Africa, the MPC would cut interest rates to support growth. The reality is that growth is already rather anaemic in South Africa even without the recent developments in Europe. We still sit with employment growth barely increasing, and the little increase that did happen was mainly in the public sector.

In an economy where the largest contributor to GDP (expenditure) is household expenditure this is a major concern. Besides, employment concerns household debt as percentage of disposable income is still too high at over 75%. A 50 basis point cut in interest rates during this meeting would not in my view light up the economy much; it would however help reduce debt servicing costs which would help the indebted households reduce their debt and improve their balance sheets, improving their ability to spend.

We know that inflation will breach the target by year end before reverting back in the first months of 2012. In this respect there is no pressure for the MPC to change its stance just to counter inflationary pressures. The change in stance, should it occur, would be more to support growth if anything, rather than as a result of potential pressure from inflation. No doubt there will still be vigilance on inflation as administered prices and wages continue to pose upward risk to inflation going forward.

We’re not looking for any change in the current MPC stance of a 5.5% repo rate and 9.00% prime overdraft rate because these are historical low rates which are supportive of debt reduction. However, the chances of a rate cut have increased significantly from the previous meeting because of the apparent deterioration in Europe and its potential impact of SA growth prospects.