By Cees Bruggemans, Chief Economist FNB
When having to make a binary decision (yes/no, whether or not to change interest rates) one is apparently well advised to, firstly, stick to the facts and, secondly, to keep things simple.
Keeping things simple preordains a view on basically two dimensions, namely the inflation forecast and the chances of getting this right, and the state of the economy (whether it is over- or underperforming).
Incidentally, these two dimensions coincide with the inflation gap and output gap dynamics of the Taylor Rule, but with somewhat different reasoning.
First, the inflation outlook. There seems to be consensus that after halving from 13.5% to 6.7% over the past year, CPI inflation has a bit more sliding to do over the coming year, reaching 5% territory in 2H2010.
That’s the good news, but it is incomplete. We want to know the chances (risk) of actually seeing this forecast materializing in reality rather than being deflected by unaccounted events.
On this score the news remains grim. Although food price inflation continues to drop, engineering a steady slide in CPI inflation, other factors are conspiring to slow down this descent or indeed start reversing it.
Electricity charges are rising heavily, services prices continue to rise rapidly, labour (union) demands remain on the high side. To this can be added an uncertain agricultural outlook (drought?).
On the positive side, the Rand has firmed and could firm some more under influence of improving global risk appetite and foreign capital inflows, suppressing our domestic price impulses. Globally, this year we are seeing deflation in many countries and only mild inflation next year, which we import, imposing yet more discipline on domestic producers.
The economy is at a cyclical bottom, with much slack capacity and increased unemployment, providing downward pressure on prices and costs.
All of that makes an interest rate decision simple, not so? Half the reasons argue for hanging tight (no change) while the other half suggests another 0.5% cut soon.
Regarding the economy, we encounter underperformance and much resource slack. This argues for low interest rates. But the SARB has already lowered interest rates by 5% since December.
Here we apparently want to know whether the economy is still weakening, possibly influencing some MPC members to vote in favour of further interest rate easing, as compared to starting to show evidence of improvement, in which case hanging tough is perhaps more advisable.
So what’s the good news, and what bad, never mind ugly?
The good news is the reflating global economy providing lift to our non-gold mining output and exports, which during January-July have increased by 14%. Similarly, electricity output has risen 7.5%, and even manufacturing production has increased by 4% since April.
Meanwhile, the SARB leading indicator turned up from April and the Kagiso PMI turned higher from May. In contrast, the RMB/BER business confidence index at 23 lost further ground in 3Q2009 and we are currently awaiting FNB/BER consumer confidence for 3Q2009.
Be that as it may (Bernanke’s favourite stomach turner), passenger car sales in August continued to disappoint (if you were a motor dealer) although the big slide seems behind us, the building trades slid further into recession, and the retail trade continued to mark time (down on a year ago, this year steadily moving sideways at low levels due to reduced household income and constrained credit access).
Credit growth is still slowing (only 3.4% year-on-year), with outstanding household mortgage debt actually slowly declining as banks maintain tough credit standards, only lending to the best credit risks at higher premiums.
With firming Rand penalising exporters, tight credit criteria restraining demand for interest rate-sensitive purchases, and consumers in any case not expressing enthusiasm to add to their durable stock, the outlook for growth recovery remains decidedly modest.
As with the inflation outlook and the risks governing it, actual growth performance and its prospects show a number of factors warranting hanging tough with interest rates, while others argue in favour of another 0.5% rate cut.
So we have two sets of arguments favouring doing nothing and two sets of arguments favouring another 0.5% rate cut at the next MPC meeting.
That focuses the attention on the composition of the MPC, and what its members could be thinking or worrying about.
It doesn’t actually help to know what individual members may be thinking as they enter into their deliberations, for a finely pitched argument in committee could sway opinion quite easily. And 51% of the vote is all that’s necessary to decide the issue.
So although we may have heard a preference expressed at the end of the previous MPC, and though speeches may have been held since, with light or heavy hinting, and untold other public interactions have probably happened during which argument flowed this way, then that way, with the financial markets continuously lurking over every MPC shoulder, it’s the flow of argument in committee that presumably will ultimately make up the minds of the majority.
And the vote?
Yes, inflation will come down further, yet there are serious risks to the forecast on the upside. However, the news out of the economy is worse, and that should weigh heavier for now. So let’s cut by 0.5%.
That was August’s decision.
Now YOU fill in the dotted line for September and see whether you guess rightly in committee next week.
Don’t despair if you get this wrong. There are still the October, November and December meetings before we all break for X-mas. Good luck.
Source: Cees Bruggemans, FNB, September 15, 2009.
