GDP growth – bingo!

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By Cees Bruggemans, Chief Economist of FNB.

Firstly the GDP growth slowdown in 2Q2010 to a seasonally adjusted annual rate of 3.2% as compared to 4.6% in 1Q2010 gives us 2.3% year on year GDP growth during 1H2010.

Given pedestrian growth performances and prospects in too many sectors of the economy, as highlighted earlier this week, we can probably expect only a modest growth gain in 2H2010, taking the expected overall GDP growth for 2010 to 2.5% to 3% at best.

This is well below long-run potential growth of 3.5% at best and does as yet nothing to narrow the now sizeable output gap, whether measured by spare physical resources or the close to three-quarters of a million jobs lost over the past 25 months.

Secondly, CPI inflation has fallen to 3.7%, also well below consensus, and by itself steadily moving the expectations goalposts as to how low inflation will go before bottoming, and how fast and high it will thereafter pick up again.

Not only are we now starting to explore the lower half of the 3%-6% inflation target more deeply, but we may linger here for longer than foreseen.

Despite the relative price changes in the public sector and a lively labour market at present, the external drivers of low inflation are to be noted. Global trade deflation is a reality, the Rand tends to be firm to the point of being 15% overvalued, and another commodity price surge does not seem an imminent risk.

It needs to be further noted that despite high wage settlements in some sectors of the economy, private employers certainly keep managing their wage bills, implying ongoing job losses and a lesser inflation impact on unit costs than perhaps generally allowed.

Thirdly, although global risks at present remain daunting in many respects, with much work unfinished before one can speak of returning to more normal conditions it is not a foregone conclusion that sudden capital flow reversals are imminent.

Indeed, the opposite risk of ongoing excessive capital inflows continues to loom larger and may well do so for some time, further reinforcing Rand strength and acting as an inflation suppressant for us

In the light of all these events, it would appear that the case for another interest rate cut of 0.5% in September has been strengthened yet further. If it were to happen, it would see prime moving to 9.5%, an event now 100% discounted by our financial markets.

More interesting now, for the goalposts never cease moving, is whether the growth trajectory will keep disappointing and the inflation undershoot surprising, for yet another 0.5% to become a possibility by (say) early 2011 as North America and Western Europe keep struggling with underperforming economies and financial systems requiring continuing monetary policy support.

The chances of such a further 0.5% rate cut beyond an imminent September rate cut may increase as the months go by. Keep an eye on markets to see the possibility thereof changing as new evidence becomes available.

Source: Cees Bruggemans, First National Bank, August 25, 2010.

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