By Cees Bruggemans, Chief Economist of FNB.
Reportedly, the SARB may only consider cutting interest rates if growth takes a (decided) turn for the worse and inflation remains non-threatening, with downside risk.
Be careful what you wish for, yet much suggests confirmation on all scores.
Though SARB is forward-looking, the present usually counts for most.
It is in the present that much evidence keeps piling up in favour of a September rate cut, financial markets now for some 70% discounting this outcome.
The latest CPI inflation data of 4.2% suggests a dip into the 3% range shortly, before bouncing back to 4%-6% over the next two years.
That makes the inflation outlook neutral. But growth does count for something as well nowadays. Though SARB and Treasury growth forecasts started the year low (remember the 1.5% GDP prognostications?), they have steadily marched higher since, by mid-year approaching 3%.
A recovering economy and an improving growth outlook are not good ingredients for expecting another rate cut, even when there is much resource slack.
But private forecasters have started to cut back their growth expectations, and may have further to retreat, at some point even affecting public expectations. That might be a different proposition altogether when it comes to interest rates.
It doesn’t help that the recessionary trough last year pushed economic activity levels very low, and that 2H2009 saw a healthy inventory and export repair bounce.
Automatically this makes 2010 year-on-year growth look good. But what’s actually happening on margin this year?
By early 2010 electricity output equaled its 2007 peak, but thereafter essentially moving sideways in 1H2010. This suggests capacity constraints (reserve buffer still single digit), but also constrained end user demand.
Manufacturing capacity utilization has moved up to 80% (still 10% below full capacity), and manufacturing output has clawed back half its recessionary dip. Output in June was 8.8% up on a year ago.
Impressive, until you realize annualized growth in 1H2010 was only 1.8% and in 2Q2010 precisely nil. Changing inventory, export and domestic demand prospects are to blame, with a strong Rand not unimportant.
Mining is worse, with output in 2Q2010 regressing anew towards early 2009 levels, undoing most of the hesitant claw-back in progress through 1Q2010.
Perhaps this is only a temporary setback? Platinum group metals, building materials, coal and gold sectors feature prominently on the downside, with only diamonds and iron ore output among the majors impressing.
Commodity export prices have not been the problem, with mining sales earnings nicely recovering. The problem is physical supply, which has returned to decade lows.
Residential building activity is still falling at this point, while non-residential building activity has also entered decline, traditionally lagging residential activity by a year.
Civil engineering activity is 40% down this year, with construction probably a shrinking sector at present.
So far we have described nearly a third of GDP, some 90% of its industrial activity. Doesn’t look good, people.
The financial sector, covering financial, real estate and business services, contributes over 20% of GDP and should be approached cautiously. Credit growth is barely 4% and bank results last week weren’t hot on promises.
Transfer fees and nominal house prices are up on a year ago, but on the margin momentum may be being lost. Credit lending criteria and borrower appetite do not suggest an imminent acceleration. Slow is the word.
That leaves three engines: household consumption via the trades, public sector consumption and the transport and communication hubs.
Government presumably is no longer leading the charge, with its finances constrained.
Household incomes are now recovering, with good retail showing expected, though income gains are narrowly concentrated, with jobs still being lost.
Transport and communication can be expected to reflect general health of the economy, which remains iffy in parts and unexciting in others.
Only car sales really boom at over 25%, but that reflects a necessary working tool whose replacement has been so far delayed as to now being far overdue, with necessity in the driving seat.
Overall this picture doesn’t promise continuing growth momentum, not even near 3%.
Meanwhile, Europe is positively surprising on the debt-cum-bank risk front and is outperforming growth expectations. Skeptics will ask for how long, but then they will always question any upside.
US growth is more worrying, but there the Fed seems ready to resume bond buying, a bearish sign for the Dollar and bullish for the Rand, with import commodity prices (oil, food) remaining non-threatening, also reflecting China’s moderating growth.
If this prospect prevails, we can expect more growth and inflation suppression, not less, from a firm Rand despite some more forex accumulation along the way deflecting a foreign capital transaction tax.
The markets are already for 70% discounting another rate cut. Evidence seems increasingly in favour of that considered market view.
The last word will be to the SARB. It should be another interesting MPC conclave. A pity it is still four weeks away, for time presses. But then it always does.
Source: Cees Bruggemans, First National Bank, August 16, 2010.
