Interest rate prospects: sharing the burden

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By Cees Bruggemans

So why would the SARB only want to cut rates by 0.5% every MPC meeting this year, prime potentially falling to 12% by yearend compared to 15% today?

Why not a little adventuresome experimentation, cutting by 1% every meeting, as potentially already discounted by financial markets or otherwise preordained by growth and inflation downsides on the back of the severe global contraction, allowing our prime interest rate to fall as low as 9% by yearend?

Or any pace in between these trajectories (say cutting by 1% one day, 0.5% the next, with even the odd pausing in between to catch some breath and much needed perspective in a dynamically changing world)?

The one thing to appreciate is risk.

Bad risk, such as capital flow turmoil, followed by Rand collapse and inflation explosion (and overstimulation of the economy by way of a deeply undervalued Rand).

The other thing to appreciate is good support from elsewhere, such as the many other overweight pall bearers at this recession funeral.

There is oil’s contribution at over -$100 (having declined by so much from $150 since mid-2008). Goodness, how much more lift do you want for the economy?

On 250mb annual oil consumption, that’s an annualized $25bn tax increase between mid-2007 and mid-2008 and an equivalent tax cut in 2H2008 – some 10% of GDP.

That’s steep stimulus after massive abstinence, though do allow for other commodity price changes neutralizing some of these effects on national income and growth (though not on inflation).

Then there’s the budget, going from 1% of GDP surplus to 3% deficit in two years in an economy that never stopped growing. That’s steep support for growth, too.

Then there is the Rand, going from fairly valued at 7:$ in 2007 to 30% undervalued on trade-weighted in 4Q2008. This is a major support for many of our producers and the labour they employ.

And then there is the global action indirectly supporting our economic outlook.

Overseas interest rates were cut to the bone during 2008, with the ECB only this month cutting to 2%, and more cutting probably coming in March.

Global fiscal stimulus of $1 trill is coming in 2009 (on top of automatic cyclical easing of national budgets).

Oil price is down by $2.5 trill annualized since mid-2008, further boosted by other commodity price declines.

It just doesn’t stop.

These are gigantic pall bearers at our puny recession funeral. With our GDP growth subsiding from an overheated 5% in 2007 to an underheated 1% in 2009, most of us seem to assume the SARB is our only pall bearer, single-handedly carrying the economy, and therefore needing to show some urgency in providing much needed support during these dire times. But it isn’t alone in this task at all.

We have many pall bearers carrying us to the grave and into the next life beyond, as a new cyclical rebound beckons from late 2009 into 2010.

Besides, there are those lingering preoccupations about external turbulence, potentially hitting our weak spot (the Rand) if we were to drop the ball and our vigilance, thereby disturbing our stability.

It is something the SARB will not want to forget to take into account, not after the experiences of 2001, 1998, 1985 and what other countries have similarly experienced with great regularity.

When it comes to growth, interest rates are only one very important stabilizing anchor, alongside the many other recession pall bearers already mentioned supporting the economy, not forgetting our sterling infrastructure effort keeping our public fixed investment elevated and preventing collapse in GDP growth.

Thus the SARB can actually afford to follow a relatively modest interest rate easing policy even as the world economy, inflation and our growth encounter surprisingly large downsides in 2009.

As a bonus such a relatively strict interest rate policy may encourage further gradual deleveraging by our indebted households, something the SARB may well welcome in terms of long-term saving behaviour, imports of consumables, the structural trade deficit, foreign capital dependency and its implied risk exposure for macro stability (Rand and inflation).

There is a huge bonus for us in moderating all these negative feedback loops.

The pay-off is in the afterlife, in the next cyclical economic upturn, facilitated by these many supporting actors, locally and globally, yet with the Rand not having gone walkabout, macro stability mostly preserved and household debt further deleveraged.

So 50 points down every meeting it is, until the SARB tells us events warrant otherwise.

For bigger rate cuts to happen, more dramatic evidence of growth and inflation slowdown so far discounted may be needed, along with improving trade data reducing our exposure to sudden capital flow stops. Also, we need proof of improving global market conditions supporting our capital needs.

We can’t be certain that such conditions will materialize quickly or that the SARB would want to respond by accelerating its policy response by cutting rates faster.

Only time will tell on all these many scores. Potentially this makes monetary policy flexible and opportunistic, but this doesn’t prescribe any one particular outcome nor precludes any.

Playing it by ear seems to be the policy prescription for these very trying, unprecedented times.

Source: Cees Bruggemans, FNB, January 26, 2009.


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