Don't bank on rate cut

ON THE face of it, it’s easy to make a case for another cut in interest rates based on economic statistics. On top of that is the New Growth Path, which called for “loose” monetary policy combined with tight fiscal policy.

But we’re unlikely to see a cut this week, and for good reason.

First, the factors that suggest there should be a cut. There’s the sluggish economic growth in the third quarter of 2.6% against 2.8% in the second quarter.

Manufacturing, which accounts for about 13% of all jobs in SA, declined sharply.
 
True, manufacturing has rebounded sharply in the fourth quarter of 2010. November’s figures were particularly strong, with seasonally adjusted growth between October and November coming in at 2.5%.

But the October/November mean was up only 0,7% from the third quarter mean, according to Citigroup economist Jean-Francois Mercier.
The Kagiso Purchasing Managers’ Index (PMI) for December suggested that there will be an increase in manufacturing output for the fourth quarter as a whole, but this is unlikely to be great shakes.
 
As Mercier says: “Looking ahead, indicators like the PMI for new orders suggest manufacturing may struggle to maintain momentum. Amidst a strong rand and corporate reluctance to invest and re-hire, growth in the sector probably will remain sluggish, and underperform most other large emerging markets.”
 
Then there’s the surprise contraction in credit in November, with annual growth of 4.6% well below the market consensus forecast of 5.6%. Does this suggest that another nudge is necessary to get credit going, especially since corporate demand for credit remains weak?

But perhaps the most important factor in favour of cutting rates is weak capital expenditure (or fixed investment spending.)

According to the Reserve Bank’s Quarterly Bulletin, real capex increased at a modest annualised rate of 0.9% in the third quarter of 2010, having increased at a rate of 1.3% in the second quarter.

Real capex by private business and public corporations rose marginally in both the second and third quarters, while the decline in capex by general government continued.

Real capex was 5.1% lower in the first nine months of 2010 compared with the same period in 2009.

Lowering interest rates won’t do anything about government’s failure to spend on infrastructure. (Capex includes infrastructure spending, and in the private sector spending on hard assets such as plant, machinery and factories.)

Government is failing to spend because of logjams. But the private sector is failing to spend because it doesn’t yet believe in the durability of the upswing.
 
Though this is a compelling reason to cut rates and make it cheaper for companies to borrow to finance capital spending, it’s not enough.

For one thing, capex is a lagging indicator, and can be expected to lag behind indicators such as consumption spending, as the private sector needs to know that consumption spending is going to last before investing.
 
The third quarter GDP figures are also not a compelling reason to cut, as those figures are historical. I’ve already referred to the more recent manufacturing statistics, but, though there’s reason for concern, it’s by no means panic stations as manufacturing growth will be positive in the fourth quarter.
 
The weak November credit growth numbers are also not a reason to cut, as they reflected a large contraction in the “investments” category, with asset-backed credit continuing to expand steadily.

Nedbank says it expects credit growth to continue rising in 2011.

 “Consumer demand for credit will continue to be supported by improving household incomes, low lending rates, better consumer confidence and attractive prices for semi-durable goods, although high household indebtedness and a tighter regulatory environment will keep credit growth in this cycle more modest,” says Nedbank.

Then there’s the fact that household consumption spending has well and truly recovered, as is clear from the monthly figures for new car sales.

Household consumption spending growth accelerated to an annualised rate of 5.9% in the third quarter from 4.9% in the second.
 
Such a strong pace of consumer spending should make another interest rate cut impossible, especially given the recent rise in food and oil prices.

In an environment of strong consumer demand, it’s easier for retailers to pass on price increases to consumers.

If they did so, inflation would rise. The Reserve Bank will be vigilant against these second round effects of oil and food price rises.

The rand’s strength hasn’t been enough to shield SA from petrol price hikes. Another small one is in the offing, after 29c/litre at the beginning of January. These all add up.
 
The monetary policy committee (MPC) statement on interest rates will be scrutinised for any sign of a future cut. That would only happen if consumer spending cools down – which isn’t impossible, given the terrible employment conditions.

For the time being, though, the Reserve Bank would make  a massive mistake if it cut interest rates now.