Data turns benign for a 0.5% rate cut

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By Cees Bruggemans, Chief Economist of FNB.

It isn’t a done deal yet. The final decision is for the SARB Governor and her Monetary Policy Committee. But the data is shaping benignly for another rate cut. As for the risks to the forecast, that is for the MPC statement to indicate. We will know in a month’s time whether the prime interest rate will see 10%.

It has been an interesting week.

Nersa granted Eskom a 25% annual tariff increase, doubling the cost of electricity these next 24 months. But that particular number has been in the SARB forecast all along, removing the huge uncertainty (and possibly sufficiently moderating the second round risks) mentioned as an obstacle to a rate decision last time.

CPI inflation for January came in at 6.2%, slightly below consensus. The main drivers were food disinflation and certain services (banks, funerals, insurance, uncannily well grouped together).

Services inflation moderated further to 6.8%, and core CPI inflation at 5.8% fell to within the target.

The outlook is for a rapid runoff in inflation through midyear, going well below 5%, with a renewed up-tick thereafter through late next year, but probably staying within the target zone.

The GDP growth data for 4Q2009 was better than expected at 3.2% annualized, confirming the recovery, but the detail didn’t yet confirm a broadbased movement.

Instead, only two sectors (manufacturing and government) contributing one-third of GDP between them was responsible for three-quarters of the increase in GDP during 4Q2009.

And these two boosters aren’t necessarily sustainable, with the Finance Minister last week announcing the intension of slowing real government spending to 2% annually, while the deep manufacturing dip of a year ago now saw positive inventory and export rebounds, which are mainly givebacks.

A remaining concern is the 50% of GDP showing further declines or only minor recoveries, with stagnation a feature, when looking at mining, retail trade, wholesale trade, motor trade, hotels, transport, storage, communication, financial and business services, with agriculture still going down steeply.

It suggests the bulk of household consumption spending and business activity generally remains constrained.

On the positive side as national income rises, some of these sectors will benefit as well. So growth momentum should gradually recover even as inventory, fiscal and export boosts eventually moderate or even fall away.

And the world cup impact and an agricultural boost in 2010 on account of the good summer rains could also add to GDP growth in the short term.

But generalized growth will probably remain a slow recovery, with credit access and usage more restrained then in previous upturns and increased public tariff charging in coming years eroding disposable income.

Thus there are two important drag anchors weighing on the economy, keeping recovery slow beyond the immediate inventory, fiscal and export boosts.

Activity levels of important sectors of the economy remain well below a year ago (mining, manufacturing, the various trades, financial and business services), indicating considerable lingering slack, also confirmed by employment and capacity utilization surveys.

Importantly, the state of the economy does not suggest an imminent resurgence of inflation pressure. SARB presentations to Parliament this week also emphasized that imported inflation this year should be minimal, wage settlements were expected to be lower, the fuel levy announced in the budget should not upset the inflation trajectory, and the Rand would likely be a neutral influence, also in terms of risk.

Thus the sentiments per the last MPC statement were mostly repeated, with really only the (great) uncertainty about the Eskom tariff increase remaining the one big outstanding risk. And on that score such concerns should now have been tempered by the 25% Nersa decision, still big but within the projected forecast of the SARB.

It all is taking shape. Inflation about to fall back within the target zone and projected to remain there these next two years. Most risk factors looking pretty benign. The one big uncertainty (and risk?) pretty much removed. And the economy now nicely recovering, but it all being mostly short-term effects so far, with underlying final demand probably recovering only slowly, much resource slack remaining and traditional boosters to rapid growth resurgence (credit, exuberance) generally missing in action.

Given that fiscal policy has provided all the accommodation it can offer to a struggling economy, and that the recovery process could do with some more assistance, with inflation and the risks governing its outlook mostly benign, there could be scope for another 0.5% rate easing, prime dropping to 10%.

We should know in a month’s time, a long waiting period to the next MPC during which much may happen. And so we wait and watch, whether events and data change the outlook or by then confirm this still early assessment.

Source: Cees Bruggemans, FNB, February 24, 2010.

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