Interest rates - Writing is on the wall
The SA Reserve Bank comes unders fire from some economists for failing to cut the repo rate last week despite rapidly deteriorating global and domestic economic conditions.
For those who believe the eurozone debt crisis can only worsen and that advanced economies will fall into recession, dragging SA down with them, the Bank’s decision not to cut rates at last week’s monetary policy committee (MPC) meeting is inexplicable.
Pan-African Capital Holdings chief economist Iraj Abedian was “absolutely shocked” at the decision. “The MPC says that all the leading indicators point towards a contraction in the economy yet they’re not going to cut rates. It’s like a driver saying that he can see all the warning road signs and even his GPS is telling him he’s about to go off a cliff but he keeps on going straight.”
On the face of it, the MPC’s bearish analysis of economic conditions does not fully support its decision to leave the repo rate unchanged at 5,5%.
The Bank is extremely concerned about the global environment, noting in the MPC statement “the deterioration in the sovereign debt crisis in the euro area and the inability of the member countries to reach agreement on a credible and workable solution”.
Emerging markets, it adds, remain vulnerable to contagion effects from a possible slowdown or recession in the advanced economies.
Governor Gill Marcus describes SA’s recovery as “fragile”. The Bank has revised down its 2011 economic growth forecast from 3,7% to 3,2% and says the risks to this outlook are on the downside.
“We know what’s coming,” says Brait economist Colen Garrow. “It’s a replay of 2008 and we should be looking at how we are going to lean against the winds of contagion.”
He believes there is scope for the Bank to cut the repo rate responsibly by between one and two percentage points over the next 18 months. “We do have some monetary policy ammunition left and should be using it to preserve GDP growth, help household budgets and keep the demand side of the economy alive.”
So why, if the writing is on the wall, did the Bank decide to wait and see?
The problem is that inflation is rising and is set to breach the target briefly in the final quarter of 2011 even as growth is slowing. The Bank’s dilemma has been compounded by the sudden, sharp weakening of the rand to over R8/US$. A weaker rand raises the cost of oil and other key inputs, putting upward pressure on inflation. Cutting rates could make the rand even weaker by diminishing its high yield attraction.
In addition, Abedian thinks the MPC bowed to two old textbook rules of monetary policy: first, when there’s volatility don’t put fuel on the fire by adjusting interest rates; and second, when there are administered price pressures in an economy don’t accommodate them with a rate cut.
“These rules had a lot of value in the old days but have much less relevance in the current crisis situation, where the whole world is saying ‘let’s act in a co-ordinated fashion’,” he says. “The Bank is out of step.”
But Rand Merchant Bank chief economist Ettienne le Roux feels it is wrong to criticise the Bank since foreign policy makers might yet act decisively on Europe — in which case events could turn around quite quickly.
“There was just too much uncertainty on the global environment and on whether rand weakness will be sustained for the MPC to cut rates,” he says. Reading between the lines of the MPC statement, however, he believes the Bank is paving the way to ease policy should the global picture deteriorate.
