Output-gap driven SARB slashes rates by 1%

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By Cees Bruggemans

At a rescheduled MPC meeting today, one of ten to be held this year, the SARB for the third meeting in a row slashed interest rates, with prime falling by 1% to 13%.

In its statement released after the meeting, the MPC put much emphasis on the extraordinary events playing out worldwide, the fact that many countries are already in recession, that industrial and export activity in many countries has fallen precipitously in recent months, also in South Africa, and that as a consequence major output gaps have opened up, locally and abroad, and that these are still in the process of deepening.

Whereas inflation in many countries has effectively ceased for the time being, with price levels in some countries actually dropping, South Africa’s CPI inflation is expected to average 8% in 1Q2009, and to steadily ease to 5.5% in coming months.

Whereas in previous MPC statements last year commodities figured centrally as a major source of inflation pressure, this time the MPC went out of its way to emphasize the cost-push nature of our inflation, especially on the services side (administered prices in particular, mentioning electricity by name).

Still, inflation in the medium term is seen to be firmly on a downward trajectory, with inflation expectations as reflected in bond yields also easing.

Given the sizeable output gap already in existence by late last year, with GDP expected to slide further this quarter and next, technically confirming a recession, the expanding output gap and resulting resource slack can be expected to put further downward pressure on inflation.

Given the country’s very poor condition at present, the falling inflation, and even when taken the Rand as major risk factor for inflation upside into account, the MPC discussed a range of 50 to 150 point cuts, but predictably split the difference, settling on a 1% cut.

Though the SARB doesn’t want us to believe so fervently that the MPC will be cutting its interest rates at each and every meeting this year, global conditions and our own deplorable state make it more than probable that monetary policy has more to contribute in helping to regain our financial stability.

While fiscal policy is making a major contribution in supporting the economy, the deeply undervalued Rand is useful in shielding important producers, and industrial policy apparently also has a bigger role to play in guiding the economy, according to the SARB, clearly the SARB itself also has still more to deliver than what it has done so far.

A simple Taylor rule, taking into account the likely output gap, inflation gap and ruling inflation these next twelve months suggest a prime interest rate of 10%-11% to be appropriate today.

Thus even at 13% now, the SARB remains well behind the curve and has further to cut. The longer it delays this process, the greater the growth sacrifice and the wider the output gap will become, accompanied by the kind of employment losses the SARB apparently rather not talk about in public.

It therefore remains a high probability that at the next few MPC meetings, the SARB will continue to cut interest rates towards the 10%-11% level, unless unexpected developments advise against doing so, or the SARB judges it appropriate to pause and evaluate the state of weakness in the economy for a while before proceeding at subsequent MPC meetings with the policy easing process.

At this particular MPC media meeting, no mention was made about the need for outsized rate cuts or for an interim meeting to consider such things, presumably because the MPC has now been scheduled to meet at least ten times a year, which gives ample time to consider events and slash interest rates as the need arises.

Source: Cees Bruggemans, FNB, March 25, 2009.


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