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SA economy needs interest rate cut boost

13 September 2011 BoE Private Clients

BoE Private Clients says that the South African economy will be given a much-needed boost if interest rates were lowered.

“At the end of July, the forward rates agreement (FRA) market had priced the probability of rate hikes by November 2011 as an almost certain outcome,” says BoE Private Clients economist Madalet Sessions.

“However the FRA market now expects rates to remain flat to lower for at least the next year, and we now agree with the rate expectations priced in the money market.”

While almost all sell-side analysts and economists had earlier predicted rates hikes either by the end of 2011 or early 2012 at the latest, BoE Private Clients has consistently motivated that it would be a mistake to raise rates in an economy that did not suffer from excess demand.

“As we have highlighted throughout 2011, inflation in South Africa is not the result of excess domestic demand but rather of administered price inflation, which runs well ahead of the average inflation rate. To raise interest rates to curb administered price inflation would be a mistake,” says Sessions.

“The Reserve Bank can only affect domestic demand and, consequently, prices that are subject to domestic market forces. Higher interest rates will do little to curb inflation, but it will slow recovery.

“As such the case for higher interest rates was always weak. We have argued that the SARB should remain accommodative to foster sustainable recovery and growth of the economy, and we are pleased that this now seems like the more likely path for monetary policy.”

Sessions says that consumption was the main driver of growth in South Africa.

“Through easier monetary policy, households are encouraged to spend. This in turn means that investment by firms becomes more likely. Firms will put capital at risk and add capacity when they are comfortable that there will be sufficient demand for that capacity. Hence, lower rates for longer – by stimulating consumption – can encourage private investment expenditure and therefore sustainable recovery and growth.”

She adds that lower interest rates for longer means that households will have cash to buy goods and services as opposed to repaying debt.

“As recently as July, the markets expected rate hikes before the end of this year. Higher rates would mean that households would be forced to forego consumption to meet interest and debt obligations. Therefore,all things being equal, the recovery is more certain if rates are going to be lower for longer.”

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