A forward-looking SARB

FNB Rex Column, by Cees Bruggermans

This coming week, the challenge for the SARB will be more than ever to be forward-looking and acting.

According to Governor Marcus, the SARB mandate is wider than only inflation targeting and includes the state of the economy and employment.

Regarding inflation targeting, the expected trajectory of inflation will be centrally in focus, not recent lows.

Then there is the state of the economy and employment.

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The case for doing nothing, leaving interest rates unchanged, is quickly made.

After a few low months in mid-3% territory, inflation is projected to rebound through the next two years, averaging 4.5% in 2011 and 5.5% in 2012-2013. Residing inside the 3%-6% target zone, mostly in its upper half.

No reason to cut rates further.

As to the state of the economy, SARB and government growth forecasts have been gradually upped this year, even as private forecasts have been shaved lower, meeting just below 3% this year and a fraction better next year.

While hardly hot, this is much better than the US, European and Japanese growth projections.

Part reason for the relatively slow South African growth is ongoing household deleveraging where implied credit normalization is presumably welcomed in a country with low savings and high structural current account deficits.

Regarding the overvalued Rand, the SARB has no clear solution except being concerned about doing the wrong thing, remembering history, ours and others.

So whereas there is some growth sacrifice implied at present relative to a long run growth potential of 3.5% (which SARB is more inclined to pitch north of 4%, given the increased investment ratio to GDP), this may be but an inevitable short-term tradeoff in favour of strengthening the structure of the economy.

Regarding employment, its heavy losses are partly to be blamed on recession and slow recovery buying structural improvement, and partly on excessive wage demands and mispricing of marginal labour for which SARB can’t take responsibility.

As to improving the economy’s long-term growth potential, SARB can contribute very little to that EXCEPT getting inflation down much lower. Other than that one looks for more human capital formation, more abstinence and higher savings rates among households and higher confidence in the economy underwriting even higher investment ratios. None of which SARB is able to deliver.

That pretty much sums up the case for leaving interest rates unchanged, with appropriate real rates in place. Time to go drinking!

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A slightly more charitable world view could twitch these arguments, perhaps enough to squeeze out another 0.5% rate cut (for now).

Firstly, financial markets have been willing to weigh the same evidence and have already lowered market rates by 0.5%. Does one really let this opportunity go by to embed this lower rate, or is one determined to show markets the many errors of their ways?

Secondly, the inflation trajectory isn’t stable, with forecasts this past year gradually lowered. What else are we still missing about the inflation trajectory?

Global inflation and trade prices may decline yet more. We would absorb this via our imports.

Commodity prices could be lower (thinking oil), given low global demand growth even as supply keeps improving.

Food prices are already very low. Could they go lower still or will they shortly rebound more than expected?

The Rand is overvalued. Overseas monetary accommodation may remain high for long. With global growth not unduly disappointing, risk appetite may tough things out, making for a weaker Dollar and yet firmer Rand.

With second-round effects from infrastructure tariff hikes so far not overly alarming, and the subdued state of the economy enough of a dampener, domestic cost-push forces may not overcome external disinflation.

Wage trends are offset with job losses and productivity gains, except in the public sector where different rules apply. The budget can absorb 7.5% but not more. A deal seems imminent, remarkably close to SARB rate decision.

This comfortable reasoning could pull the inflation trajectory in 2010-2012 down another notch compared to some forecasts of a full rebound back to 6%.

With risks of another overseas crisis reduced (unless one wants to interpret the world differently), and our domestic growth unnecessarily held back by debt reduction in the household and corporate sectors, the economy’s incentive structure could do with another slight nudge.

With no scope to give tax cuts, our high real interest rate regime in a prolonged slow growth environment should perhaps be reconsidered.

Case made for another 0.5% interest rate cut (for now). Time to go drinking!

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As to reality, the Committee will deliberate in its own good time as scheduled and dispense as and when.

Another rate cut now would be judicious and not irresponsible.

It should have been given much earlier, but that’s water under the bridge. Every day is the first day of the rest of your life, and we are focusing on future trajectories.

But it would be good politics. Finance Minister Gordhan has hinted as much. Excellent reason not to grant a cut.

Cees Bruggemans is Chief Economist of First National Bank. Register for his free e-mail articles on www.fnb.co.za/economics