Close call, governor

READING through the published speech Reserve Bank governor Gill Marcus delivered early in July makes me think that we will see another cut in the repo rate. But the governor appeared to try to douse these expectations in off-the-cuff comments. Nevertheless, it remains a close call.

Marcus' apparent attempt to quash expectations of a cut was her comment that policy guidance wasn't necessary at the time of the speech, although at times it was "because there's a view out there that needs to be engaged".

This would seem to imply that her previous guidance, that the repo rate would remain at 6.5% (prime 10%) for a while, stands. Still, a few economists out there, such as Bank of America/Merrill Lynch, are betting on a cut.

What sparked the hopes of another cut was Marcus' focus on the global financial crisis. She said: "The reality is that we probably never really emerged from the crisis, which is now entering its next phase."

Paying particular attention to the budgetary problems in Europe, she said: "The fiscal adjustment in Europe and the UK means that growth is going to be very low for some time, perhaps not even in positive territory ...

"In the US, consumption expenditure is not recovering at the pace initially expected, as high levels of unemployment, a de-leveraging banking sector and a weak housing market remain a constraint on households still faced with excessive debt."

Although the International Monetary Fund has been very positive about growth in Asia and some other emerging markets, Marcus sounded a pessimistic note on China.

She said: "China and the Asian region in general, as well as some countries in South America, are seen as the main growth poles.

"However, there are signs that the policy-induced slowdown in China is having some effect... The fact that this cooling down is taking place at a time of a more general slowdown has reinforced the increasingly negative global outlook."

Dousing the flames of hope

For SA, she noted that the Reserve Bank still expects gross domestic product (GDP) growth to average 3% this year.

The general tone of her speech was so downbeat on economic prospects that for some it sounded like she was paving the way for a cut – until she herself seemed to douse those flames.

One factor that would work against this is the recently released retail sales data for May, which showed retail sales rose by a solid 1.3% month-on-month and a respectable 4.6% year-on-year.

At the same time, the Reserve Bank's recent Quarterly Bulletin showed that household consumption expenditure rose 5.7% in the first quarter of this year. (Consumption expenditure differs from retail sales by including services, and being released quarterly.)

The rise in household consumption expenditure of 5.7% stands out as a sign that the consumer, for so long punch drunk, is finally back in fighting form.

One of the reasons why consumer spending is expected to stay strong is above-inflation wage increases. Against that background, a cut in interest rates may  fuel inflation.

But, on the other hand, the manufacturing sector seems not to be benefiting enough from the consumer's resurgence. True, manufacturing output was up 0.3% month-on-month in May, which was better than expected, but output lost momentum in the second quarter. The Kagiso Purchasing Managers' Index has raised pessimism about the sector.

Elegant argument for a world in crisis

It's also important to note that, while consumer spending is recovering, it's not at the levels it reached during the boom years.

Recovery is coming off a very low base – household consumption expenditure recorded no less than five consecutive quarters of negative growth before rising again (1.6%) in the final quarter of 2009. Moreover, households remain highly indebted and spending on credit is very low.

So, the economic evidence can be read as allowing for one more rate cut. I would argue against it, as rates are likely to stay low for long, and the bank must be careful not to repeat the mistakes made by Marcus' predecessor, Tito Mboweni, who shouldn't have cut rates in 2004 and 2005.

Those two rate cuts created a psychology of easy money which induced people to spend on credit as if there was no tomorrow.
 
In the past, I have argued that Marcus' rate cut that took the repo rate to 6.5% was a step too far. I now think it was the right course of action, and that I had underestimated the global crisis.

Credit growth has only recently turned positive again, and Marcus' speech was an elegant argument that the world is still in the doldrums.

Marcus' speech, instead of being seen as a signal of a rate cut this week, should be read as an explanation for her last rate cut. It's probably also a message that rates will remain low for long.

On both scores, she can't be faulted. 

 -  Fin24.com