Should prime be lower?

Much is being made of the fact that credit extension to corporate has been slow to recover, due both to firms’ uncertain outlook on the future and banks supposed reluctance to relax lending criteria. Exporters bemoan the fact that rand strength is eating away at their attempts to shore-up lacklustre domestic demand with foreign contracts, while beleaguered local consumers and businesses are being taxed at every turn.

The strength of the rand has played a major role in bringing consumer inflation down to 3.5%, in turn allowing for prime to be reduced to a 30-year low. But was unemployment at 25.3% in 1979 and company failures at levels of 1,300 per annum compared to around 4,300 now?

This begs the question as to whether interest rates shouldn’t in fact be lower than they currently are. The graph below shows real prime – simply Consumer Price Index (CPI) less prime – compared to the South African Chamber of Commerce and Industry’s Business Confidence Index. The latter is taken as a quantitative proxy for business activity. As the economy has cooled over the past two years, so interest rates have fallen (helped in turn by falling inflation). While economic activity has improved this year, this is off a very low base and the Kagiso Purchasing Managers Index suggests that momentum may be losing traction. Yet over the past 12 months, real interest rates have climbed some 2%. We see justification for rates to be cut by 100 basis points; this will assist cash-strapped business and consumers alike. Cheaper goods are on many shelves already and should boost Christmas sales but the nascent recovery is not assured.