By Cees Bruggemans

The SARB decision last week to resume cutting interest rates is interesting, given that our CPI inflation is likely to only modestly decrease further towards 5% next year, even as global growth keeps signaling its return and our own economy likewise signals a turn in progress.

What does that make the SARB action?

Are we being unnecessarily impatient with results, reminding of 2002-2003? At the time rates were probably cut too far, eventually inviting excessive consumption and import booms. Are we now running similar risks?

Or do current circumstances warrant vigorous policy support for longer, making sure the cycle does turn?

We certainly haven’t lacked with policy support measures boosting the economy in these trying times.

The SARB lowered interest rates by 450 points in six months through May 2009, while Treasury allowed an even bigger fiscal turnaround than imagined (from a budget surplus of 1% of GDP to a massive deficit of 7%-8% of GDP today), a switch of over 8% of GDP in two years.

Most importantly, the global economy hasn’t been standing still. The financial panic of September 2008 triggered a kneejerk output cutback in 4Q2008, but thereafter things stabilized all round from 1Q2009 due to global policy intervention and a gradual unwinding of overreaction.

By 2Q2009 Asia was rebounding, G3 capital good orders were recovering, and it now materializes even France and Germany were getting back on the growth bandwagon.

The Anglo-Saxon economies lagged, even as their rate of decline slowed dramatically in 2Q2009, their consumers taking longer to recuperate. But with the pace of inventory destocking slowing, 3Q2009 pushes even them back onto a GDP growth trajectory.

Perhaps it will prove a weak Western growth recovery eventually once the inventory correction and fiscal stimulus have run their short-term course as consumer fundamentals apparently remain fragile, for which reason many Western central banks are signaling a remarkable willingness to remain obliging for longer, thereby safeguarding the recovery process.

As someone described it last week, the Fed’s mission apparently remains “full employment or bust!” If the weakest global link argues thus, and the rest is already coming back in any case, that’s a very powerful signal.

And all that matters to us. Asia taking off anew. Europe coming out of its slumber. And even the Anglo-Saxons belatedly resuming growth, with their macro policy vigilant to ensure recovery continuation and preventing banking and growth relapses.

Our SARB gives the impression of now imitating the Anglo-Saxons. It also apparently questions the strength of recovery globally and locally. If so, it mirrors Fed questioning of whether US recovery is just a promise or for real, talking about its economy currently merely ‘levelling out’ rather than punting the recovery theme.

This reflects lingering Fed concerns about fragile consumer fundamentals, a still ailing banking system and eventually the ending of short-term boosts from fiscal stimulus and inventory destocking, thus persistently questioning recovery sustainability.

Clearly the Fed and also the BOE (and probably even the ECB) do not want to leave anything to chance, nor accept any signs of recovery on face value. They want to be sure, apparently doubly sure, even triply sure, that this great evil (crisis) has been fully addressed and is really receding and ending. No deflation or Second Great Depression on their watch, having learned deeply from events 80 years ago!

So our SARB is actually in good company as it seemingly emphasises growth downside rather than upside, now apparently opting for increasing the medicine dose just to make sure recession doesn’t linger.

Even so, we don’t have dysfunctional banks and capital markets like the Anglo-Saxons have, warranting extreme caution, though we do have cyclical tightening of credit standards (and some structural change in banking cultures as well, at least in the short term).

We have had strong policy stimulus, commodity prices are firm and recovering, and our trade partners are swinging back into action. This is echoed domestically in key sectors of our economy.

Non-gold mining output fell by 23% between October 2008 and January 2009, but has since then recovered over 9% by June 2009.

Electricity output fell by 10% during October-February, thereafter recovering 5% by June.

Even our manufacturing output seems to have started to turn, falling by 15% between September 2008 and April 2009, rising 1% by June 2009.

Admittedly the manufacturing bounce has so far been weak, presumably because important industrial export sectors will take time getting favoured by overseas sourcing multinationals, something we can do little about (except striking and demanding less and being more productive).

As to our households, the FNB/BER consumer opinion survey through June 2009 continued to suggest now isn’t as yet a good time to buy durable goods, continuing the postponement of major replacement decisions, something that was reflected in weak new passenger car sales through July, though used car demand seems to be recovering (as one would expect early in recovery).

Retail data show an intimidating pattern, namely gradual weakening in real year-on-year sales growth ever since mid-2007 as household disposable income was gradually eroded by higher inflation and rising debt servicing, but then an abrupt step-down in sales volumes as we entered 2009, yielding large year-on-year sales volume declines.

It was as if yearend bonuses fizzled (they probably did), employment losses bit deep (they certainly did in 1H2009), a deep contraction in other forms of household income took hold (as recession deepened, confirmed by lower tax receipts) and consumers generally became more cautious (anecdotally they probably did), not least because nominal house prices continued to decline (undoubtedly an unnerving experience for many of our households) even as the global financial crisis offered a fearful spectacle (for many it certainly did).

So we observe deep retail weakness despite a rapid runoff in interest rates reducing debt servicing during 1H2009, generous ongoing budget support, and wage settlements increasingly catching up as CPI inflation halved yet wage increases in protected employment going ballistic into double-digit territory.

Retail turnover, adjusted for inflation, shows an abrupt falloff yet a sideways trending pattern in 1H2009, with monthly seasonally adjusted real sales (Rbn) of 39.1, 38.0, 39.3, 38.6, 39.4 and 38.3. Trying to read a pattern into that oceanic swell is rather challenging, except to say it is clearly weaker than last year (undeniably so) and not going anywhere in a hurry (apparently so).

The main weakness has been in textile, clothing, furniture and appliance retailing (suggesting postponing replacement) and doubly so for hardware merchants (reflecting a weak housing market and curtailed building activity). Though retail weakness has not been limited to these areas, its source is clearly domestic.

Even so, national income will gain from recovering external trade and local output, aside of spending incentive provided by lower interest rates, with rising equity values providing their own tonic, and nominal house prices probably starting to level out over the coming year. Traditionally households have responded to such improving fundamentals by increasing their consumption, and the present cyclical turn is unlikely to be an exception. It is probably a matter of time.

Yet the SARB seemingly has belatedly chosen to re-emphasize the downside in all of this (rather than perhaps more understandably still doing so in June when the urgency was more universally recognised).

The cyclical turn now probably taking shape was acknowledged by a reference to the leading indicator turning up, but one gains the impression of this as yet not being bought wholeheartedly or not seen as being sufficiently vigorous (leaving unstated by what benchmark).

Admittedly we now have the National Credit Act enforcing its tough love, and banks seem to have relearned some old credit lessons, not least going by global example, but does such disciplining of the economy weigh up against the domestic stimuli and global support in the making?

Time will tell. Meanwhile we are now probably in the process of leaving recession and are increasingly forced onto an expansionary trajectory, not least because the SARB is making doubly sure it is by actively manning more domestic pumps.

One notes, however, that turning points apparently remain difficult transitions. In hindsight the SARB was probably late in starting to ease policy in 4Q2008 (and being far too gently in doing so). Today we again have to worry about policy doing too much, or indeed too little, in supporting the economy and potentially worsening the cyclicality of the economy.

Source: Cees Bruggemans, FNB, August 17, 2009.

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