Pouring oil on troubled waters?

The MPC reduces the repo rate by 50bps to 7%, and confounds the analysts, including the IMF who suggested in a report recently that the central bank should increase the repo rate, if it were to meet its inflation targets.

Governor Tito Mboweni says that when the inflation rates are under control and they (the MPC) have their finger on the pulse, they have room to manoeuvre,especially when inflation expectations from the experts are on the low side, there is that much more room.

Mboweni says that the MPC says that the outlook for inflation is that CPIX would remain in the target range for the next two years. Although the overall performance of the country is OK, there is some slackening in local productivity the rand has traded in a slightly higher range than last year.

“We don’t live in a different world. Inflation targeting is not there for its own sake – its there for the overall betterment of the local economy. The reduction should have some impact on the exchange rate, and make it more globally competitive.”

Mboweni, speaking on the second day of the MPC meeting, said that over the past two months the world has been characterized by uncertainty, confounding expectations of a short lived spike, due to the oil price volatility, which saw petrol prices locally increase by 65c per litre.

Most recently there has been a slacking in the manufacturing sector although the inflation outlook has remained favourable, and remained in the target range for the past 18 months. The outlook for growth and exports locally will depend on international growth.

Interestingly services inflation has continued its gradual downward trend, the first time since inflation targeting was introduced.

The outlook for inflation remains favourable in spite of the oil price uncertainty. There is no short term risk. However further possible increases in the petrol price could have an impact on the CPIX inflation expectation. On average it is expected to be at 4.5% for the year, and remain in the target range for the next three years.

The perception within a surveyed group in South Africa seems to be that these low levels can be maintained.

Not all the positive factors from the last MPC prevail – unit labour costs being one aspect, with labour productivity growth down.

There are some upside risks – the uncertainty relating to international oil prices being the predominant one. The outlook for oil is increasingly uncertain. On the local front domestic expenditure remains robust, while the strong growth in the private sector continues.

Chris Hart, senior economist at Absa says: I think it’s an excellent decision and at an opportune time. It can be considered a brave decision in the light of negative shift in sentiment concerning interest rates in the last couple of months,

“I believe it’s a decision that shifts away from the fears surrounding inflation, and closer to the realities. It also prepares the way for further cuts this year, but not likely at the next MPC meeting.”

The repo rate cut willresult in lower bond rates - thus more disposable income to the publicin general, specifically those withbonds to repay. To the investor in traditional interest rateproducts it is bad news particularly to the older investor who is reliant on income from these products or interest from fixed deposits.

“It's the time for alternative products to be developed for this market enabling them to still earnhigh fixedrates but linked to other markets instruments such as equities, property and derivatives.” Rene Miles - head of investments at Channel Life.

Rian le Roux, Head of Economic Research at OMAM (SA) today said that the rate cut was very unexpected given the unsettled global environment, strong domestic demand growth and already sizeable deficit on the current account of the balance of payments.

The Bank's decision was based on its perception that inflation prospects remain good and that the sustained strong rand is inflicting unnecessary damage to domestic producers. The Bank specifically mentioned evidence of some slowdown in certain sectors of the economy.

Looking forward, the behaviour of the Rand and inflation over the next few months will determine whether the rate cut may have to be reversed later this year or next.

Notes:

* Gross savings as a percentage of gross domestic product saw a decline in the last quarter of last year from 15% to 13.5%. This was mostly due to corporate savings that declined, after they declared more dividends and paid more tax. Household savings were steady as was the government contribution.

* Total new vehicle sales continued to climb – the highest for the past 20 years, with a small decline in March. Sales people are still earning good commission, although the prices are fairly subdued due to the exchange rate, although stimulated by good financing deals on offer.

* Manufacturing production volumes declined in January and February. There is some weakness having peaked in the third quarter of last year, although not consistent in the various sectors. Furniture was up, while food production was down.

* Non agricultural sector employment is good news. With an increase of 4% since the last quarter – the public sector showed an increase, but less than the private sector – this is the sixth quarter of increases.

* The most recent official unemployment rate is said to have declined from 27.9% to 26.2%.

* Production price inflation was muted, and prices were lower than they were 12 months ago

* Headline inflation and CPIX was down, with CPIX at its lowest levels yet.

* Administered prices were marginally down below the 6% level – petrol played its role there, and there was some volatility.

* Imports and exports pulled back slightly, although exports rebounded more. The overall picture is reflected in the trade balance, with the deficit now fairly significant.

* The country’s current account was in deficit last year.

* The real effective exchange rate of the local currency saw 4.5% depreciation.

* The credit extension best performer was home loans, followed by car installment and lease payment schemes.

* Asset prices saw house prices climb steadily, with bonds down as were share prices. They were at close to record levels.