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At its last meeting held in October, the IMF said that the global economic slowdown was worsening. They once again cut global growth forecasts, revising this year’s figure downward from 3.5% to 3.3% and next year from 3.9% to 3.6%. The South African economy is expected to expand by 2.6% this year and only 3% in 2013. This downward revision largely reflects the negative effects of the strong links South Africa has with Europe – which is expected to contract by 0.4% this year – as well as the country’s supply side constraints, particularly on the electricity front. The committee suggested that the country may have to rely on monetary policy by way of a further interest rate cut to cushion the effects of the global slowdown.
At the July MPC meeting, the Reserve Bank decided to cut the interest rate (Repo Rate) by 50 basis points to 5.0%; thus reducing the South African Prime interest rate at 8.5% (the lowest since 1946). Prior to this rate cut, the MPC had left rates unchanged for 9 consecutive meetings at its 30-year low rate of 5.5%. The July cut was followed by a decision to leave the repo rate unchanged at the MPC’s September and recent November meeting – the decision to hold being an active one as the bank has repeatedly pointed out.
Unfortunately the country not only faces a difficult outlook in terms of economic growth, but is also challenged by a worsening inflationary position. Headline CPI increased to 5.6% in October -up from 5.5% the previous month (core inflation, as measured by the exclusion of food, petrol and electricity from CPI, measured 4.7%, unchanged from September). The CPI rate is projected to average 5.6% for 2012. This has been fueled by elevated global food and oil prices as well as increasing housing expenses. Although this figure has dropped back down to a more manageable level, it is the vulnerability of a fluctuating Rand that remains the real concern. Labour strikes, a widening current account deficit, the rating downgrades and uncertain political position all keep the Rand – and consequently inflation - under pressure.
Having said this, the Reserve Bank appears to be relatively confident that inflation will remain contained and within the 3% - 6% target bracket. They are more concerned about the economic outlook and are expecting greater deterioration for the remainder of the year. This suggests that the argument for another interest rate cut could be on the cards.
Any further rate cuts will be seen as an attempt by the MPC to provide the South African economy with some growth stimulus (or cushion against further growth deterioration). However, given the vulnerable Rand (which could weaken further on the back of a decrease in interest rates) and the fact that any further easing is unlikely to have a material impact on the economic growth outlook (as the weakness is stemming from the production side of the economy), the MPC is faced with an incredibly tricky situation.
While some of the banks believe that a rate cut will occur, with the timing thereof being the only unknown, our view is that the Reserve Bank will keep rates on hold at their current level through 2013. While the argument for a rate cut may strengthen if the South African growth outlook deteriorates further it will be difficult for the Reserve Bank to cut rates further in the face of an inflation rate which is higher than the REPO rate, and which has potential upside risks due to Rand volatility and supply side disruption.
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