The market is currently factoring in the possibility of a 25bp cut in the repo rate by the end of the year with almost 100 percent certainty, although many view this as a 50 percent chance of a 50bp cut (i.e. 0.50 percent).
The market is currently factoring in the possibility of a 25bp cut in the repo rate by the end of the year with almost 100 percent certainty, although many view this as a 50 percent chance of a 50bp cut (i.e. 0.50 percent).
However, with the repo rate at 5.00 percent, the likelihood of a 25bp cut has increased significantly, as opposed to the 50bp downward trajectory that the repo rate has been on since 2009.
The SARB has also indicated that it could cut by 25bp (should the factors it assesses in deciding on the appropriate stance of monetary policy tip the balance toward a cut) now that the repurchase rate is at a low, of 5.00 percent.
A 50bp cut when the repo rate is at 5.00 percent would have a 10 percent impact and could prove to be too severe. This does not mean that a 25bp cut is a certainty this year, but rather that the probability has risen.
We ascribe a 45 percent chance of a 25bp cut at the MPC meeting this month, on 21 and 23 May, and a 55 percent chance that no cut will occur this month.
Our forecast for flat interest rates therefore remains this year, although there are a number of factors which appear to support a cut from the extension of easy monetary policy globally to domestically, the ongoing weakness in production, very low level of consumer confidence and weak business confidence, rising unemployment and continued economic growth below potential.
With the unions demanding, and in many cases being granted, substantial wage increases for the members they represent, wages remain on an upward trajectory in SA in real terms, unsurprising given the rise in the cost of living on the back of rising administered prices, particularly electricity costs and water tariffs, rising rates and taxes for home owners (or higher rentals), along with the high debt burden.
The majority of indebted households fall into the middle income category.
Indeed, close to half of credit active South Africans are impaired (three or more payments in arrears or have a judgement, administration order or adverse listing).
There is no doubt that the high cost of living is eating into household budgets, in what is essentially driving the demand for high wage settlements.
Consumers are deleveraging but unemployment is still rising.
The Rand’s weakness and resultant higher inflation is also driving the significant pressure for wage increases.
The risk of a wage price spiral is clear and inflation has risen from 3.1 to 5.9 percent year-on-year since 2010, as the Rand has weakened from R6.72/USD to R9.30/USD and wages have risen sharply.
While the SARB notes the manifestation of a wage price spiral, it is not evincing particular concern.
Typically when the FRA curve factors in a rate cut and the SARB does not make any attempt to talk the market out of such a belief, it means the SARB may be contemplating such a cut.
Many consumers are over indebted, but the near-usurious rate charged for microfinance means not only have the banks involved in consumer finance been making high levels of profits from this sector.
The middle to lower-income earners are suffering under excessive costs of borrowing, but a 25bp cut in interest rates will not offer any meaningful relief when the interest rates charged are in double digits.
A 25bp cut in the current environment is likely to be more negative for the Rand and carry trade than providing any real support to the economy.
A 50bp cut would see the rand weaken more significantly as foreigners fear temporarily for their yield.
Further interest rate cuts could imperil the debt issuance plan of government, with many African countries also now issuing high-yielding, medium risk debt.
While we forecast an interest rate hike in April 2014, this forecast has been made on the likely need to begin the normalisation process of interest rates, i.e. start moving the repo inflation differential to the neutral range of around 2.0 percent.
Since SA’s last recession, which began in Q4 2008 with growth slowing sharply earlier in the year, the repo inflation differential has dropped frequently into negative territory.
However, should economic growth not strengthen considerably over this period then the interest rate increases will be delayed.
We do not expect the repo rate to rise much above 6.00 percent over the medium-term unless the economy experiences a boom period and demand led inflation rises well above the inflation target for a prolonged period.
The biggest risk to our forecast remains an interest rate cut over the period.- Annabel Bishop
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