The resurgent rand has put the South African Reserve Bank (SARB) under increasing pressure to cut interest rates despite SARB governor Tito Mboweni’s repeated warnings that speculation of an imminent interest rate cut is premature.
These warnings were first issued on January 16, when the rand was trading at R8,85 per dollar.
The rand rallied strongly on Thursday, reaching its best level against the greenback since July 2001. It touched R8,02 to the dollar.
Many economists and two-thirds of fund managers believe that since the warnings were first issued, circumstances have changed significantly for the better in terms of the pro-active inflation targeting regime the SARB is supposed to follow.
“Until such time as we see inflation moving significantly in the right direction, it is premature to start speculating about any changes in interest rates,” Mboweni said on January 16, 2003.
On January 15, 2002, the SARB announced an interest rate hike of 100 basis points, even though the latest available inflation data at the time showed that the inflation target measure of CPIX, which was for November 2001, had just gone above the target range of 3% to 6%, by 0,3 percentage points, as it was at 6,3% y/y after having dropped from 7,7% y/y in January 2001.
South Africa’s inflation rate had been pushed higher by the collapse in the rand in the fourth quarter 2001. The rand reached its worst level of R13,86 per dollar on December 20, 2001, and is now – more than 400 days later – more than 70% stronger at R8,02 per dollar.
The reversal in the fortunes of the rand meant that imported producer inflation peaked at 17,4% y/y in April 2002. This then filtered down to the domestic and producer inflation rates, which in turn peaked in August 2002.
At the consumer level, the major factor pushing up inflation had been food inflation. This has been on a downward trend since October, when it peaked at 19,8% y/y. The food inflation rate fell to 15,5% y/y in January from 16,1% y/y in December.
“The inverse yield curve and the negative real credit extension data show that the SARB is unnecessarily restrictive. The inflationary pressures are historical and if the SARB waits until June to cut interest rates, it will be behind the state of the economy,” said Absa economist Chris Hart.
The Absa economists believe that the SARB should cut interest rates at the next Monetary Policy Committee (MPC) meeting in March.
The majority of South African economists have heeded Mboweni’s warning and therefore only expect a rate cut at the June MPC meeting.
The forward interest rate market has been pricing in a 50 basis points easing for the March 19/20 Monetary Policy Committee (MPC) meeting, a 130 basis points easing from current levels by the June 11/12 MPC meeting, a 215 basis points easing by the September 17/18 MPC meeting and 270 basis points by the November 26/27 MPC meeting.
In 1999, South Africa cut its prime rate eight times, from 23% in January to 15,5% in October. Mboweni at the time was responsible for the day-to-day running of the SARB, while he only officially took over as governor in August 1999.
The consensus forecasts of economists in January 1999 was that the SARB would only cut five times and the bottom of the cycle would see the prime rate return to the March 1998 low of 18,25%.
Similarly in 2001, when the prime rate was cut three times from 14,5% to 13%, the consensus forecast at the beginning of 2001 was that there would be no change in the prime rate during 2001. Economists said at the time that the delay in privatising Telkom, which is still not listed, would put pressure on the rand and may in fact prompt an increase in interest rates.
The SARB had increased the repo rate by 25 basis points in October 2000 in response to the pressure on the rand.
The most recent pressure on the SARB to cut interest rates has come from the example of other central banks, which have cut in response to global economic weakness.
In November last year the US cut interest rates and in December the European Central Bank also cut in response to renewed weakness in the global economy.
Most recently, the Bank of England, which last cut in November 2001, two months after the SARB’s last cut, decided to surprise the market on February 6 by cutting interest rates to their lowest level since 1995.
The Czech and Hungarian central banks also cut in January this year in response to their strong exchange rates. South African exports plunged by 21% in November from October in response to the downturn in global demand and fell a further 7% in December on November.
In December 2002, the imported producer inflation rate was only 10,3% y/y, while the domestic and all items producer inflation were at 13,1% y/y and 12,4% y/y respectively. Absa expect the January producer inflation rate, due to be reported ion February 26, to come in at 8,1% y/y.
“A single-digit producer inflation rate would be the final piece in the forward looking inflation jigsaw puzzle that would make an interest rate cut in March appropriate,” Hart said.
Most economists expect the y/y base effects to push the SARB’s inflation target measure, CPIX, which excludes the effect of mortgage interest rates, within the 3% to 6% target range by the second half of this year.
The good news on the inflation front due to base effects will, however, be mitigated by a rapid slowdown for the same reason in real economic activity data.
Already real retail sales have slowed down to a 2,4% y/y in November from September’s 4,4% y/y rise, while manufacturing production declined by a seasonally adjusted annualised 3,7% in the fourth quarter from the third quarter 2002.
Adding to the pressure for a rate cut was the collapse in the y/y growth rate of credit extension to the private sector in December of 4,75%, its lowest y/y rate since 1966, from 9,18% y/y in November and a recent peak of 20.58% y/y in May 2002.
When the great economist, Lord John Maynard Keynes, First Baron of Tilton, was asked why he kept on changing his policy prescriptions in response to changed circumstances, Keynes replied: “I change my mind when the facts change. What do you do, Sir.”- I-Net Bridge