IT'S easy to take a cynical view of the economists who are all suddenly forecasting a 50 basis point cut in interest rates this week. Is this view based on their reading of the data, or has there been a whispering campaign from the Reserve Bank?
In the past, when Reserve Bank governor Tito Mboweni made policy decisions no one in the market had anticipated, he was roundly criticised. The Reserve Bank is supposed to be transparent and if he conducts policy and communicates with the market in a transparent way, decisions will generally not come as a surprise.
There are limits to this transparency, of course. Not even the world's greatest central banker sage will know for sure what he is going to do long before the monetary policy committee (MPC) meets, and sometimes it's tricky, even close to the meeting.
This time around some believe it's a difficult call, so it's no wonder there's been little on the record from Mboweni. He has half-heartedly said that the MPC will take the country's GDP performance into account as well as global conditions when making its next interest rate decision. But - and it's a big but - Mboweni also says the bank isn't going to take its eye off the inflation ball.
What Mboweni should do and what you think he will do are two separate things. Economists sometimes confuse the two, predicting that Mboweni will do what they would have done had they been in his place. This is a mistake to be avoided ? but not an easy thing to do, because it entails reading Mboweni's mind on the data already available to the market.
I am going to stick my neck out and say that Mboweni is going to cut rates this week. I will go into the arguments in favour of a rate cut in more detail, but the main reason for my faith is a cynical belief that the many economists who are predicting the rate cut have had their expectations "managed" by central bank officials.
Teetering on the brink
The case in favour of a rate cut is mainly based on SA's poor gross domestic product (GDP) performance in the third quarter, and the weak outlook for GDP. GDP grew by only 0.2% (quarter-on-quarter, seasonally adjusted and annualised) in the third quarter.
If agriculture, which did exceptionally well with a real growth rate of about 16%, is excluded, there was small negative growth in the third quarter. This means the non-farm economy is already teetering on the brink of a recession; another quarter of negative growth and the technical definition for a recession in the non-agricultural economy will have been met.
More importantly, GDP statistics show that SA's retail sector is already in a recession, with two quarters of negative growth. What this shows is that interest rate hikes have done their job: tighter monetary policy has killed off consumer spending. This is also abundantly clear from new car sales, which have been in a non-stop slump for almost two years.
This tells us that there can't be any demand pressure on inflation. Consumer demand in the economy is basically dead. This can't be a source of concern any further for the governor, and as demand is the way in which interest rates influence inflation, he should be ready to cut rates.
Upbeat inflation outlook
One could argue, however, that the Reserve Bank has to keep squeezing demand to offset other sources of pressure on inflation (such as food prices). My opponents would argue that demand should remain dead to ensure that retailers can't pass on cost increases to consumers. However, I believe this is overkill.
Looking at the inflation statistics, it's also clear that the corner has been turned and that inflation is now on a downward trend. Granted, the peak (13.6% in August) was high and inflation is still double the upper limit of the 3%-6% target.
But there are two reasons to be optimistic about the inflation outlook. One is the fact that the consumer price index (CPI) basket will be reweighted and rebased in January, which is expected to slice about two percentage points off the inflation rate. The other is that the oil price has fallen sharply, offsetting any concerns a weaker rand might have caused.
There?s no need for the central bank to wait ? as some think it will ? to see what the rebasing and reweighting of the CPI will bring next year. We already know that there will be a positive impact and the Bank can react to that now.
Some economists (Standard Bank, the Efficient Group) believe inflation will be inside the target range by the third quarter of next year. Others, such as the Bureau for Economic Research, think this will only happen by 2010. My guess is that the MPC's new forecast will be for inflation inside the target range by at least the end of next year, giving the bank ammunition to cut rates without looking as though it is reneging on the battle against inflation.
Against this compelling case in favour of a cut is the view that the rand is a danger to the inflation outlook. But with oil prices falling, the effect of rand weakness will be limited, and as long as the central bank plays it safe with a small cut in the repo rate ? 50 basis points ? things should be all right.
- Fin24.com