MPC meeting likely to keep rates unchanged

The Monetary Policy Committee (MPC) decision on the monetary stance will be announced on Tuesday afternoon. Although the MPC decision will be phrased in terms of the inflation target, there is no doubt that the state of the local and international economy, which impacts on inflation, will be discussed in great detail.

Globally, economies are emerging from recession. Economic growth is likely to be tardy; the possibility of a relapse in growth cannot be ruled out; the impact of monetary and fiscal policy is not fully understood; and concerns exist that the removal of accommodative monetary policy may come either too late, resulting in high inflation, or too early, nipping the recovery in the bud. In addition, fiscal deficits and government debt have reached levels unheard of only a few quarters ago, with the developed world particularly vulnerable. More positively, most of the important emerging markets have emerged from the crisis less scathed and are showing promising signs of firmer growth.


The main channels through which the global economy will impact on the South African economy are our exports, the exchange rate, the global interest rate cycle and capital flows. The global recovery has seen export orders improving, which have underpinned production growth in the manufacturing sector, despite the strong rand exchange rate. Instead, the strong currency is likely to curtail inflation expectations and will, in due course, benefit real purchasing power, which is critical for a revival in household consumption. It is also important to note that while consumer goods disinflation will become entrenched on account of lower import prices, services inflation, which now accounts for a larger share in the inflation basket than before, will dilute the rand’s impact on overall inflation.

On the local scene the economy remains vulnerable. The demand side remains constrained, with households not resuming the acquisition of new debt. Household debt as a ratio of income remains stuck at elevated levels and will require the process of deleveraging to continue for some time. The increase in unemployment adds to the general feeling of melancholy that the economy suffers from. As far as capital formation is concerned, private investment is still reflective of the general uncertainty in the economy. Government spending will be hampered by the decline on the revenue side of the Budget and the soaring deficit. This leaves the change in inventories and exports as potentially the major drivers of the economy over the next few quarters. Admittedly, these concerns raise the prospects for a cut in the interest rate next week. However, further monetary policy relaxation will not translate into employment growth or stimulate private sector activity. While the over-indebted will benefit from more affordable debt repayments, retail sales will not necessarily revive. The chief reason is that job shedding created far more destruction in the retail sector and affected a broader share of the economy. Only around 14% of the adult population directly benefits from lower interest rates given their exposure to credit.

The economy is currently operating below capacity and stimulating the economy in the form of an interest rate cut is a typical response. However, clouding this view is the fact that the interest rate easing that started in December 2008, and amounted to a sizeable cumulative 500 basis points, may not yet have worked its way fully through the economy. The inflation rate, however, is expected to be pushed higher when electricity tariffs are announced towards the end of February.

The repo rate is expected to remain unchanged at 7% next week and for the rest of the year until September.

Extract from Weekly Preview, Standard Bank