Welcoming the rate cut and prime 10%

FNB Rex Column, by Cees Bruggermans
 

It isn’t as if the economy now only has tailwinds blowing its recovery along.

The Minister of Finance will be reducing his budget deficit for a number of years in part by slowing growth in government spending. That’s a headwind.

The Rand has gained ground over the past year and the global forces driving it may not be finished. That’s a headwind, too.

Then there is the matter of heavily loading public tariffs – electricity, tolls. These are taxes by another name. That’s more headwind.

These are all DEMAND headwinds. They inhibit spending and the creation of income in the hands of consumers, companies and investors.

There are also SUPPLY headwinds. Two big ones come to mind. One is failing infrastructure reaching its limits and constraining output (and new investment). The other is a new credit culture imposing more stringent criteria and asking a higher price relative to prime than before.

These aren’t small constraints. They are big.

Clearly, supply constraints need to be addressed by the appropriate authorities. The public sector is still the main gatekeeper for infrastructure management and new investment. It need to do more, but may well be constrained in its ability to do so. The alternative hope is that in the absence of a more forceful government push, private initiative may come to the rescue.

Much talk concerns both these aspects. We must quietly watch, wait and see what happens. In the very short term very little may.

As to credit, banks will lend to good credit risks at a risk-adjusted price. It means we forgo the easy lending practices of past years.

Both these realities will keep growth back, but there is apparently very little that can be done about this.

A different reality applies to the demand side and its asset price companions. If demand and income improve relatively slowly, and the economy performs below potential (given the spat of labour layoffs and idle plant this past year), some policy stimulus may well be warranted if it doesn’t feed into inflation.

Monetary policy has remained quite tight throughout the recent adjustment. First inflation went up, then the Rand collapsed in late 2008, and throughout there was much handwringing about upside risks to the inflation outlook.

It didn’t make for a relaxed policy stance.

But time and events move on. Actual inflation is back in the target zone, inflation expectations seem to be easing and if anything inflation risk is for now on the downside (considering food, Rand, output gap and very low global inflation imported here).

With inflation prospects modestly tamed (something apparently mostly in the eye of the beholder), it is common sense not to keep interest rates unduly high.

When seen against the backdrop of only a gradually improving, underperforming economy there comes into view the possibility of further stimulus by way of rate cuts.

This would bolster asset prices, already bolstered by global events and the fact that interest rates have been lowered substantially from their cyclical peak. Thus the economy’s incentive structure was given a further fillip. This may assist household budgets, freeing up disposable income, and encouraging replacement normalization. On the business side it may encourage bigger order flows, inventory positions and investment decisions, in turn creating yet more income in consumer hands.

One shouldn’t overstate the effect of the eleventh 0.5% rate cut in changing spending and output decisions. Yet psychologically it may well prove to be an outsized event, pushing more hesitating consumers, investors and business managers into making bigger bets.

Given expected inflation levels these next two years, the balance of risks covering them, and the state of the real economy as it gradually rediscovers its bearings, keeping interest rates unchangingly high might not have been the clever thing to do.

This economy has some way to go before finding its balance once again.

Unfortunately, outside events won’t stand still as we engage in our adventure to see the economy recover with present policy supports.

Both globally and locally, things keep evolving.

One set of combinations would lead to an early SARB about-turn and the commencement of policy tightening. Yet another set of evolving events could keep the SARB unchangingly ‘low for long’. And yet another set, global in nature, could surprise us, further firming the Rand and rearranging our inflation and output behaviour to the point of meriting yet more rate easing.

Many will differ about exactly which road we will be traveling, this aside of anything we ourselves will still be adding to the pot (thinking Julius and friends, but not only them).

Our global windfalls may not be at an end and we apparently remain an asset buy, sometimes even in spite of some of us. Policy will find itself challenged to counter such forces with further policy fine-tunings as compared to riding out the cycle, given the many vocal backseat drivers in attendance.