The central bank decided to reduce the repo rate by 50bps to 5% today. The decision followed an extended period since December 2010 where the policy interest rate remained stable at an already low level. Today’s decision means that the prime lending rate will decline to 8.5% - a multi-decade low.
In what SARB Governor Gill Marcus characterised as a “robust discussion” to reach the decision, the rate verdict will come as somewhat of a surprise to domestic financial markets that only discounted a small possibility of a reduction in July. Besides the BER, only one other economist polled by Reuters and Bloomberg expected a cut. The financial markets – and many analysts – discounted a larger possibility for a reduction later in the year.
In the BER’s recently published Economic Prospects publication, we set out the reasoning for why we changed our rate call to a July cut: “Since the previous BER forecast update in April, developments on both the inflation and GDP growth front have forced a rethink of the interest rate forecast. The inflation outlook has brightened over the last three months, while growth prospects have deteriorated.” On the growth front, the consistent message that came across in the BER’s 2012Q2 business surveys, i.e. of a general slowdown in output growth and lower levels of confidence, was an important influence in our call for a July rate reduction.
The statement from the SA Reserve Bank’s Monetary Policy Committee (MPC) that accompanied the decision corroborated our sentiments. Not only was the central bank’s inflation forecast revised down for a second consecutive meeting, but the statement is scattered with words such as “worsened” and “deteriorated” to describe both the global and domestic GDP growth outlook.
Because ensuring price stability remains the SARB’s main mandate, a key factor that influenced the MPC’s decision was the improved inflation prospects. After reaching a peak of 6.1% y-o-y in 2012Q1, the SARB now expects CPI inflation to ease further to a low of 4.9% during 2013Q2 and to remain fairly stable around 5% through the end of 2014. CPI is forecast to average 5.6% in 2012, down from 6% projected in May. Because monetary policy works with a lag and is supposed to be forward looking, more important is that the average CPI forecast for 2013 was revised down to 5.1% from 5.5%. CPI is expected to remain at 5.1% in 2014, i.e. consumer prices are forecast to be well within the 3 to 6% inflation target range in 2013 and 2014. The SARB’s revised CPI views are somewhat more favourable than the BER’s updated forecast of 5.7 and 5.3% during 2012 and 2013.
Of particular importance is that the SARB’s forecast for core inflation (headline CPI excluding the volatile food, transport and energy components) is also more favourable. After rising from June’s 4.6% y-o-y to a projected 5.4% during 2012Q4 and 2013Q1, core inflation is expected to moderate to an average of 4.8% in 2014. Better than expected inflation outcomes in recent months were the most important reason for the improved price outlook. Whereas in May the SARB argued that the risks to their inflation forecast were on the upside, they are now characterised as “evenly balanced”. The recent uptick in global and SA grain prices, as well as the higher oil price, are mentioned as inflation risk factors, but according to the MPC they are offset by many other commodity prices that are set to remain benign. Despite the recent gains, the oil price remains well off its highs closer to $130/bbl reached earlier in 2012. The relative resilience of the rand exchange rate in recent times is also mentioned as a countervailing force to the inflation risk factors.
Concerning the GDP growth outlook, as expected the central was less optimistic than in May. Growth is forecast to average 2.7% in 2012 compared with a forecast of 2.9% presented two months’ago. Growth is expected to accelerate to 3.8% in 2013 (3.9% projected previously) and 4.1% during 2014. Especially in terms of the SARB’s 2013 forecast, there seems be significant downside risk as it compares with the latest Reuters Econometer consensus of 3.3%, which is also the BER’s updated forecast. Indeed, both in the MPC statement and during the media Q&A after the decision, SARB Governor Gill Marcus highlighted that the risks to the SARB’s growth forecast are on the downside. Particular mention is made that the negative spill-over effects from the worsening global growth outlook, including softer emerging market growth trends, to SA “are likely to intensify”.
Outlook
The further improvement in the SARB’s inflation forecast provided it with some freedom to act to alleviate “some of the pressures faced by some sectors” of the economy. We agree with the MPC’s assessment that the rate move on its own will not overcome the challenges faced by the economy, but at the minimum it could instil some confidence in households and the business sector.
Because the rate reduction was already incorporated in the BER’s June forecast update, it will not change our short-term outlook for the SA economy. At this stage, we expect the repo rate to remain at 5% through the end of 2013. It could be argued that by already moving today, the MPC has tried to pre-empt the spillovers to SA of more trouble in the global economy. However, a continued deterioration in global and domestic growth prospects - especially if accompanied by a renewed oil price decline and thus even more benign global inflation - may well result in further monetary policy easing.