Downside bias in SA interest rates

Posted On Friday, 22 February 2013 08:08 Published by eProp@News
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Though binding supply constraints (electricity, credit access, public sector manpower) and poor export dynamics explain much of South Africa’s 2.5% subpar growth performance during 2012-2013, there is enough of a business confidence restraint to also keep demand back.

With inflation averaging near 6% this year there is more real household income erosion ahead at a time that credit support (unsecured) is being cut back, implying more of a consumption slowdown than perhaps expected.

Furthermore, leading global central banks are conducting ultra loose monetary policies, with their super liquidity boosts reflating global equities and causing huge bond inflows to higher yielding EM markets, potentially also boosting Rand firmness and giving rise to asset bubbles (at least in our bonds and equities).

Globally, these tendencies are depicted as currency wars, with EM countries with rising currencies inclined to ease monetary policies to prevent currency overvaluation.

Together, such excessive domestic strains and external liquidity injections suggest the potential for further SARB interest rate easing.

Holding up such moves in the short term are a humping SA inflation rate (rising mostly for technical reasons, but also carried along by longer term infrastructure repricing), higher food and oil commodity price levels, the unruly labour climate potentially generating more excessive wage demands (even to the point of becoming a wage-inflation spiral) and the fears as to what all this domestic unruliness could do to foreign capital inflows (any sudden stops capable of generating a Rand shock weakening, in turn detonating our inflation yet higher).

But will these concerns last out the year? And if they don't, would that clear the way for SARB to lower SA interest rates by another notch?

The global monetary policy picture is unlikely to change this year or next (or for that matter soon thereafter). Rich world repair will take a long while during which leading central banks can be expected to stick with ultra loose monetary policy, despite the many misgivings aired daily on the subject in some quarters, with free and frank advice flowing furiously without yet seemingly converting the leading central bankers.

Similarly, our binding internal supply constraints do not show evidence of lifting quickly.

Despite many influences playing in on our inflation, such as oil, food, infrastructure repricing and global trade disinflation (and outright deflation), our inflation will seemingly remain mostly in the upper part of the 3%-6% SARB target range, except for short periods off the reservation (such as expected through mid-2013).

Such relative inflation stability probably also owes much by now to a credible inflation-targeting record of the SARB, in the process causing expectations to increasingly converge and remain anchored in the SARB's target range.

This achievement is not limited to ourselves, but is mirrored in firmly anchored inflation expectations in many countries.

Though the inclination of inflation to stay near the upper reaches of the target range is not wholly satisfactory, SARB can likely live with such an inflation performance (considering the historic backdrop and the structural strains weighing on the SA economy), relative to an underperforming economy capable of doing better if only for a bit more demand, yet fiscal policy being played out and unable to assist.

This makes the two key tactical concerns of the SARB this year the labour climate and foreign investors deciding our volume of capital inflows and the level of the Rand.

If the labour unrest, in line with 2003-2012 tendencies, were still to deteriorate further, living off a menu of increased violence, clashing unions, flaunting of the rule of law and excessive demands fired up by a sense of expectation and entitlement, the SARB is likely to lean into such unwelcome tendencies.

If, accompanying such labour unruliness, foreign investors were to acquire yet more cold feet about investing in our assets, in the process causing even more Rand weakness, also stoking inflation pressure higher, SARB would have double reason to hold back on any further policy easing in support of a weaker economy.

But it isn't written anywhere that these are the only certain outcomes this year guiding the SARB.

On the labour front, the cold common sense of employer adjustments to excessive labour demands will likely continue to be to manage their wage bills carefully in line with strenuous import and local competition.

Any above-average wage increases not matched with labour productivity improvement is likely to be matched with greater mechanisation and labour shedding, and a yet greater focus on foreign expansion in friendlier climes.

For what it is worth, the State of the Nation speech in a rather understated manner (and perhaps for that reason the more ominous) promised swift application of the law for any citizens not staying with peaceful protest.

Between the state and employers, the spreading culture of labour violence in support of extreme demands may meet its match this year.

Wishful thinking? Perhaps.

Let's see how coming months play. There will be major wage rounds between now and 3Q2013, during which the patience of many will be severely tested.

Yet it need not all go one-way as was perhaps the main impression gained last year. There are countervailing realities, not least if jobs are progressively axed, and the law makes a stand as vaguely promised.

If by 3Q2013 there clearly isn't a wage-inflation spiral taking hold, and ultra-loose global monetary policies keep matching higher risk premiums demanded by foreign investors, causing a kind of suspended animation for the Rand in 8.50-9.50:$ territory, the SARB's worst concerns could start to abate gradually.

It is then that the weak demand condition of the economy may regain centre stage, also by that time still 6-9 months away from the next general election.

Local financial institutions on the whole do not really believe in further SARB easing these next 12 months, yet some foreign financial institutions apparently do. With inflation staying acceptable, yet growth increasingly not, their focus is on more SARB easing.

To which I would add that the risk of rate lifting may be receding beyond 2015, in line with leading countries overseas and our long period of subpar growth performance still very much remaining a reality for long.

On balance, I am not assuming a shock deterioration shortly (labour and/or Rand based). Instead, I expect our inflation to remain bearable while subpar growth and zero formal job growth like last year won't be acceptable.

It is a combination that might invite more policy easing ere long, with a constrained fiscal policy and a Rand stuck in suspended animation not giving enough support, leaving it for SARB to apply a bit more thrust to the economic engines, assuming that our asset markets aren't yet so white-hot as to pose concern for SARB.

The easy thing in such an environment is still not to do anything, explaining that enough has been done and any more would be irresponsible, in line with such thinking in certain quarters overseas.

But more EM central banks seem now to be preparing for some more interest rate easing in line to their own domestic and external circumstances.

Our SARB may not turn out to be the exception also doing so. But first let's see what this labour round brings, and what foreigners will do with their capital (and in the process with our Rand).

This doesn't preclude an early policy response these next four months, all these things ultimately being in the realm of opportunistic policing.

But it is more likely that 1H2013 will be spend watching and learning, while 2H2013 could offer opportunistic windows of policy activism, especially if a flock of EM brethren were to lead with their chins, clearing the way for us to follow in their wake without getting too heavily penalised in the process.

Prime to 8% in 2013?

Source: Cees Bruggemans

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