Interest rate prospects

There remains considerable uncertainty as to where interest rates will be heading next. Even so, the cycle has its own inner logic, aside of any policy fine-tuning driven by the state of the economy, inflation performance and political considerations.

With past cycles for inflation and growth in mind, we can reasonably assume such forces to repeat themselves over time, given a fairly stable structural context.

We are currently in low performance territory for both growth and inflation. We will eventually recover and peak out anew, after which a new subsidence will occur.

If driven by moderate forces, this suggests a prime rate range of 10%-15% as a standard cyclical expectation.

Only exceptional dislocation (weak currency, high oil price, drought-related food price increases, disastrous public sector charging, strong labour action or any combination of such developments) would suggest renewed inflation momentum making for an upside breakout, prime possibly exploring 15%-18%.

Similarly, different global forces making for a much stronger Rand and subdued commodity prices, with local factors more benign, could see resumption of our convergence with low OECD inflation below 2%, creating potential for a downside breakout, prime potentially exploring 7%-10%.

These tail conditions (prime rate of 15%-18% and 7%-10%) may have a lower probability than the standard range (10%-15%), but for that one is relying on institutional continuity. Yet the world is hardly stable. Instead it is evolving, gradually in an underlying sense, but at times also shock-like.

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We are an open economy, with sizeable import penetration. We are at present importing low global inflation AND our currency is in a firming phase. We are currently economically underperforming and are unlikely to outperform again soon, suggesting lingering resource slack, while we also benefit from productivity gains. These forces are all anti-inflationary.

Yet for many South Africans it is an open-and-shut case. We are a high-inflation country, unable to restrain our inflation, and therefore saddled with a depreciating currency over time.

But try telling this to the government and the SARB, whose inflation targets and inflation-targeting policy suggest something different.

It may well be that institutionally we have difficulty in converging quickly with global inflation norms. Such shortcomings are the same as those that keep our growth shackled at relatively low underperformance levels when judged by modern global standards, limiting the pace of our structural change and general uplifting.

There is nothing new in any of this. But sometimes one has to restate the obvious in order to draw the logical conclusion as to why a cyclical prime interest rate range of 10%-15% is so standard for us while most of the world sits at half that level.

Source: Cees Bruggemans, Chief Economist of First National Bank