Global case for SARB delaying rate hikes

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By Cees Bruggemans, Chief Economist of FNB.

When projecting inflation to double to over 6% shortly, even a still modestly performing economy should not keep the SARB from taking back some of its recent interest rate generosity, considering that it allowed real interest rates to fade beyond to where they strictly should be under ‘normal’ conditions.

But there probably still is another case for holding back with rate hikes, potentially as long as possible.

This shines through in the commentary about external risks, and the uncertainties surrounding these, without getting too explicit.

Apparently, we must leave something for the imagination, even for markets. No one wants to cry wolf too often or become known for telling scare stories.

Still, the external picture is an intimidating one.

If there were to be a European crisis this year or next (or the year thereafter), would it endanger our exports, pulling our economy into recession, the way Lehman’s failure and the US events surrounding it did in 2008?

Given that our growth is still modest, and unevenly dependent on consumption, it makes for considerable growth downside (and potential inflation dampeners)?

But also consider that if there were to be a European debt (and existentialist) crisis, even if it were not to end in disaster, this could be very positive for precious metals as hedges.

A disastrous European playout would be even fuller of mayhem, uncertainty and anxiety and potentially a precious metal positive.

Add to this picture the uncertainty, anxiety and potential mayhem still to be had in the Arab world and the way this could influence oil supply security. But similarly potential market disturbances in the US regarding its budget fights and sovereign debt playout, in China regarding the way credit and housing bubbles are being addressed (adequately or not), even regarding Japan (debt), many emerging markets (inflation) and the unease with which Fed monetary policy experimentation is being followed globally (cerebrally exciting but emotionally grating on the nerves).

In short, a massive precious metal surge would presumably pull the Rand stronger with it, potentially eroding our inflation bulge, itself mostly commodity based.

When one adds all that up, what do you get?

Possibly only modest growth, but with sudden downside potential driven by external events.

Inflation resurgence but with global dynamics plausibly providing turbo power to precious metals, capital inflows and Rand firming (even from current already elevated levels), thereby potentially eroding the inflation surge.

It doesn’t HAVE to happen. Just the risk of it happening, however, is enough to consider options carefully.

And if it WERE to happen?

Our SA playing field could abruptly change in favour of keeping interest rates unchanged (if not cutting them). It depends on how much growth was being lost and how much inflation would fade instead of surge further.

Not knowing which reality will play for real, one solution is to buy time, wait and see as long as possible.

For though there isn’t much time left before action may become imperative, with the economy growing over 3%, inflation surging towards 6% and second-round effects becoming more evident, there nevertheless is still time to act timely.

And these hypothetical global crisis conditions are not a vague far distant potential. These are playing out this very moment in real time.

Financial markets want the Eurozone to address peripheral sovereign debts and their own weak undercapitalized banks.

Eurozone electorates don’t want foreign bailouts and may not take kindly to the realization of the losses at pension funds and insurers and the recapitalization burdens of banks.

The natural inclination is to seek out the weakest link, which are the peripheral countries, insisting they will make every effort to create their own solutions out of their problems.

But realistically only so much can be expected here, the financial markets are growing more skeptical, and the own electorates more rebellious at even the THOUGHT of having to incur even a single penny in expressing solidarity.

Eurozone political elites have so far by clever moves and stealth bought much time, and more time can presumably still be bought this way. But indefinitely so?

Instead of compromise or yet more cleverness one senses an endgame in progress, which may well in stages end up successfully finding solutions or progressively leading to the break up of the European monetary union, with new configurations taking its place.

Much excitement apparently lies ahead, with could yet inject more volatility in markets.

American budgetary politics and debt dynamics may similarly cause increased market unease at some point. And similar risk potential can be observed in the Arab world, China, even Japan.

Given these uncertainties and their apparent scale, do we really want to start raising interest rates in response to rising inflation at home any time soon, given the potential of thereby firming the Rand yet further?

For if growth dampening and further assaults of incoming commodity and capital windfalls need to be absorbed by the Rand, we have potentially a situation on our hands in which a super strong Rand could materialize, by itself eroding the coming inflation surge, partially or wholly.

Depending on how one sees the global risks, it might well pay handsomely to go slow with the finger on the interest rate trigger.

There is still time to see how things play globally and decide how this will affect us, and thereby deciding which policy action is most advisable.

So wait? And see?

Source: Cees Bruggemans, FNB, May 13, 2011.

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