The start of the American invasion of Iraq and the consequent collapse in oil prices to three-month lows should result in the South African Reserve Bank (SARB) Monetary Policy Committee (MPC) agreeing to cut interest rates.
In similar circumstances in September 2001 the MPC did decide to cut interest rates to combat uncertainty despite a sharply weaker rand. At the time the MPC gave three reasons why it cut interest rates.
The first reason it gave was the effect of the tragic events of September 11 2001 on American consumer confidence. This is now lower than it was in September 2001.
The MPC also said ”macroeconomic data for Europe and Japan also remained disappointing, while economic strains in Argentina, Brazil and Turkey adversely
affected sentiment towards emerging-market economies.”
The second reason was that the ”downward movement of global interest rates has continued” and this has continued since the last meeting of the MPC in November 2002, with the European Central Bank cutting twice since then, while the Bank of England cut in early February 2003 for the first time since November 2001.
The third reason why the MPC did cut interest rates was because it expected ”world inflation rates to be contained”. This remains the case with euro-denominated global traded goods in a deflationary mode.
In January, imported manufactured goods in South Africa fell by 0.5% m/m and were only up 3.4% y/y. The decision to cut in September 2001 was taken despite the ”increased pressure on exchange rates in a number of economies, including South Africa.
The rand immediately depreciated against all the major currencies. As a result, the trade-weighted value of the rand on 20 September 2001 was 11.5% below its level at the beginning of the year.”
Today the rand is at R8.18 per dollar compared with 8.70 on September 20 2001 and 10.66 at the September 2002 MPC meeting. The strength of the rand therefore makes it easier to do the right thing and cut interest rates.
The Merrill Lynch survey of South African fund managers support my opinion that the MPC should cut on Thursday, as a record 77% of fund managers believe that monetary policy is too tight.
The pressure comes for various sectors of the economy 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 8.85 rand per dollar, but the rand reached 7.8357 on March 5, a 24-month best level.
”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.
On January 15, 2002, the SARB announced an interest rate hike of 100 basis points, even though the 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.
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.
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 in December 2002 have fallen by 2.9% since May 2002, 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?”
The American invasion of Iraq, the strong rand and the collapse in the oil price since its peak on March 10 2003 are all part of the changed circumstances
that did not apply even a week ago. – I-Net Bridge