scissors

To cut or not to cut will be the crucial decision as South Africa’s monetary policy committee holds the first of its fourth quarter meetings this week in an environment of gloomy growth prospects and inflationary pressure.

The Reserve Bank, which is generally credited for its prudence, has left interest rates unchanged at 5.5 per cent this year.

That follows cuts of 650 basis points between the end of 2008 and the end of 2010 to 30- year lows after the global economic crisis swept across Africa’s largest economy. South Africa has tentatively recovered in 2011, which Jacob Zuma, the president, optimistically dubbed the year of jobs.

But in recent weeks a swathe of negative data, particularly in manufacturing, has caused economists to revise down their growth forecasts to around 3 per cent for the year.

The current global uncertainty has merely added to sombre mood causing some to predict the possibility of a rate cut before the end of the year.

Yet at the same time inflation has been gradually rising, with the CPI hitting 5.3 per cent in July up from 5 per cent in June.

Traditionally, the Reserve Bank looks to keep inflation within in a band of 3 per cent to 6 per cent and it has previously said it expects that ceiling to be broken in Q1 of 2012.

The key, analysts say, will be what the MPC’s deems to be the most immediate threat – slowing growth or rising inflation in an unpredictable global environment.

This week, Goldman Sachs said it expected a cut to 5 per cent before the end of the year, arguing that the “underlying inflation dynamics should remain benign through 2012.”

The investment bank said in a research note:

With weaker than expected growth in Q2 and a significant further deterioration in the Q3 data, the growth outlook for South Africa is not looking particularly upbeat. Our recent‘recession probability’ analysis suggests there is a 72% chance of at least another quarter of sub-par growth. Incorporating this into our forecasts, we now expect the economy to contract in 2011Q3, and revise our growth forecasts to 2.8% in 2011 and 3.0% in 2012, from 3.0% and 3.5% previously.

Underlying inflation dynamics should remin benign through 2012 and we therefore now expect the SARB to cut rates by an additional 50bp to 5.0% in 2011Q4. However, this stimulus is likely to be temporary, and we see the SARB starting to normalise policy in late 2012H2. We see rates at 5.50% at end-2012, implying a cumulative tightening of 50bp in2012H2.

The risks to our revised forecasts are on the downside: a deeper and more prolonged global slowdown and/or negative credit shocks could result in a weaker growth trajectory and therefore an even larger output gap in South Africa. This could prompt the SARB to ease further. But we are not there yet and the hurdle for the SARB to ease beyond our current forecasts seems relatively high, given the already accommodative policy stance and strong inflation inertia.

On Tuesday, Barclays Capital said it expected the MPC to keep its “powder dry for now.” Noting that data released on Tuesday showed that South Africa’s leading economic index (LEI) had declined to 134.3 in July from 135.5 in June, Barclays Capital said:

The deterioration in the July LEI follows a host of disappointing macro data on the economy of late and underpins the recent downgrade to our GDP growth forecasts for South Africa. We now look for the economy to grow just over 3.0% in 2011 versus our prior expectation of 3.9%.

The release of this morning’s LEI will no doubt get the SARB MPC meeting (which starts today) off to a relatively sombre start and, together with its heightened concerns on market and economic spillover from the deteriorating environment in Europe, is likely to culminate into a relatively dovish statement on Thursday.

We believe that the SARB MPC is likely to keep its powder dry for now and keep rates “low for longer”; though a read of the committee’s perceived balance of risks between global and domestic economic developments will be key in deciphering the way forward for policy rates, in our view.”

Dennis Dykes, chief economist at Nedbank, told beyondbrics that another issue the MPC has to consider is how much of a stimulus a rate cut would actually be. “There’s no doubt the mood is very sombre. One thing that might concern the Reserve Bank is that it’s not all that evident cutting interest rates at this stage would necessarily inject a huge amount of stimulation into the economy,” he said.

“At the moment everybody would say growth would be our biggest problem … but the Reserve Bank and the MPC, in particular, have to look forward 12 months to 18 months and make a guess as to what’s going to be happening at that point.

“The chances of some sort of easing have increased significantly … But our central scenario is they will keep it unchanged and keep monitoring.”

The guessing will no doubt continue until Thursday when the MPC is set to make its statement after what is expected to be its most interesting meeting of the year.

Further reading:
S Africa: inflation barges in, beyondbrics
FT interview with Jacob Zuma, transcript
South Africa cuts rates 50bp, FT Money Supply

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