The South African Reserve Bank (SARB) opted to leave the repo rate unchanged on Thursday at 6,5%. This was in line with the market consensus, although one out of the 22 analysts surveyed had expected a further rate reduction.
The Reserve Bank last adjusted interest rates in March 2010, when it surprised the market with a 50bps reduction. The prime interest rate remains unchanged today at 10%, which is the lowest prime rate South Africa has experienced since January 1981. The next Monetary Policy Committee (MPC) meeting is on July 21 and 22 2010.
In making the decision to leave rates unchanged, the Reserve Bank highlighted the following:
- The SARB inflation forecast indicates a slightly improved outlook compared with that presented at the previous meeting of the MPC, with a lower projected inflation for 2010 and 2011.
- Inflation is expected to remain within the inflation target range until the end of the forecast period, which has been extended to the end of 2012.
- Domestic economic growth prospects appear to have improved and most growth forecasts have been revised upwards, despite only a modest recovery in household consumption expenditure.
- Despite the more favourable growth outlook, employment trends appear to be lagging the domestic recovery.
- The global developments also highlight the current focus of the financial markets on the sustainability of fiscal deficits and debt ratios. The South African fiscal trajectory is consistent with fiscal sustainability.
- There is a concern about the possible impact of the level of wage increases in the economy. The MPC noted that a number of wage negotiations are at significantly higher levels, and well above the current and expected inflation rate.
- The risks to the inflation forecast are seen to be more evenly balanced than at the previous meeting of the MPC.
- The main risks to the inflation outlook emanate from administered price developments and from the risks emanating from the global economy.
Overall, the Reserve Bank is clearly very comfortable with the outlook for inflation, with the main downside risk being food prices and the main upside risk being wage increases and administered prices (electricity, water, toll roads etc).
Furthermore, the Reserve Bank appears to be a little more convinced, certainly relative to two months ago, that the South African economy is on a solid enough recovery path.
Lastly, the bank is obviously monitoring the European fiscal difficulties very closely and recognises the current increased risk of contagion and market volatility. The increased risk of volatility/contagion would have added to the decision to keep policy rates unchanged.
One could argue that there is still an opportunity for the Reserve Bank to cut rates, but this would require a noticeable change in the current inflation and/or growth outlook.
Inflation is already projected to remain acceptably low for a considerably period of time, so in order for the bank to cut rates further, the current economic recovery would have to falter or stumble materially. This is not my base case expectation. Rather, I would expect the bank to keep rates on hold for the remainder of 2010 and into 2011.
Kevin Lings is the economist for Stanlib.
Visit Smart Money for more news, blogs, tips and Q&As. Post questions on the site for independent and researched information.