The prime interest rate is to drop to 11% after the Reserve Bank opted on Thursday to lower the repo rate, at which it lends money to commercial banks, to 7,5%. The decision, which caught the market by surprise, was prompted by an improved inflation outlook said Reserve Bank Governor Tito Mboweni. This is the first rate cut since December 2003.
This rate cut caught the market by surprise as economists had unanimously expected the Reserve Bank’s Monetary Policy Committee to leave rates unchanged. The Reserve Bank last year cut interest rates five times by 550 basis points in total.
Many commentators have charged that the Reserve Bank risked going out on a limb as the only central bank cutting interest rates, while all others around the world are raising rates. This however is contrary to the facts, as there are numerous central banks, including the Bank of Canada, that have cut interest rates this year. In particular, the European Central Bank is under increasing pressure to cut interest rates to stimulate growth in the Eurozone area.
”It is always wise when things change to change one’s mind,” Mboweni said prior to announcing the decision of the bank’s monetary policy committee. ”It is a very bad idea to be dogmatic,” he said — conceding that the decision might surprise some.
Mboweni said the inflation outcome in the first six months of the year had been more favourable than expected. Consumer inflation minus mortgage costs (CPIX) was lower than forecast.
”The lower base, combined with the recent rise in the value of the rand, has resulted in a lower projection for CPIX inflation in the next two years,” the governor said.
CPIX was not expected to breach the upper limit of the bank’s three to six percent target range.
”These results are expected to be achieved in combination with robust growth rates in domestic production as well as demand,” he said.
The Reserve Bank’s aim is to keep inflation within the range of 3% to 6%. Most economists still expect inflation to stay within range this year, but there is increasing uncertainty about official economic data and fuel price policy.
The June retail petrol price in South Africa has risen by 30,7% from June 2003, but the Department of Minerals and Energy (DME) capped the June increase at 30c/l, instead of the free market 38c/l rise. So far the DME has not informed the public as to what the fuel price policy is after June, but continues with its ad hoc monthly change. The latest oil price surge points to a 20c/l rise in September after a 23c/l cut in August.
Banks cut rates
Following the Reserve Bank’s decision, Standard Bank, Absa, Nedcor (Nedbank), FNB, Old Mutual Bank and Peoples Bank announced a 50 basis point decrease in both the prime overdraft rate and the mortgage rate applicable to home loans — from 11,5% to 11%.
FNB’s Michael Jordaan commented: ”The rate cut is most welcome, this will boost growth, create new jobs and enhance confidence. Inflation figures remain the key driver in interest rate movements.”
Jordaan added that savers need not despair. Lower inflation means that returns on fixed deposits remain in positive territory.
Union commends interest rate cut
South Africa’s National Union of Mineworkers (NUM) on Thursday said it was pleased with the decision to cut rates.
”This is a bold and encouraging move by the governor and the Monetary Policy Committee (MPC) and, certainly, flies in the face of those who thought that interest rates would not be lowered at this stage. We would like to believe that this reflects seriousness of the bank and the governor to the concerns raised by mineworkers in the interactions we’ve had with him. We hope that the markets will respond positively too,” said NUM General Secretary Gwede Mantashe.
The lowering of the interest rates comes only a day after NUM marched on the Reserve Bank to request the governor’s intervention given that the strong rand is playing havoc with mineworkers’ jobs.
”It also comes after previous one-to-one interactions with the governor. Although we wish not to claim easy victories, we do believe this action indicates that the governor and the MPC heard the voices and cries of the ordinary workers who are facing a possibly bleak future,” the Mantashe said.
SACOB hails Mbwoweni’s decision
The South African Chamber of Business (SACOB) also welcomed the Reserve Bank’s decision.
”SACOB is of the opinion that this rate reduction will not fuel inflation but rather compensate for the oil price and rand strength’s negative impact on the economy and will assist in sustainable economic growth,” the business organisation said in a statement on Thursday.
Surprise cut sends rand tumbling
The rand was sharply weaker against major currencies in late afternoon trade after Mboweni announced the surprise rate cut.
At 16h00, the rand was quoted at R6,4426 per dollar from R6,2175 just before Mboweni delivered the MPC’s statement and an overnight close of R6,2151. It was quoted at R7,6434 to the euro from a previous R7,5857 and at R11,4900 against sterling from Wednesday’s R11,3690.
”The weakness is all on the MPC,” said a market analyst, describing the MPC’s decision as a ”hell of a surprise”.
”The cut severely dents the carry trade, particularly in light of expected further increases in the interest rates in the US,” the analyst explained.
The carry trade relates to the favourable interest rates differentials between South Africa and its major trading partners. It involves international investors borrowing at low-interest rates and investing in high-yielding ones.
According to London-based Consensus Economics’ August survey, the carry trade is the most important determinant of exchange rates.
”We see the rand targeting R6,51 at first, but there is talk it could weaken to R7,00 per dollar in the not too distant future,” the analyst concluded.
The last time the rand traded above R6,40 per dollar was June 21. It was last above R6,50 on June 18 and R7,00 on May 11.
– I-Net Bridge, Sapa