10 April 2005

INTEREST is once again rising in the Great Rates Debate as this week’s meeting of the Monetary Policy Committee (MPC) draws near. The MPC is the Reserve Bank’s longest running serial. Every episode adds more suspense.

The big drama came in August last year when the MPC reduced interest rates by a further 50 basis points to 11%, a 24-year low. Events showed the MPC was spot on. Inflation continued to fall and the economy continued to grow. What’s more, the rand remained firm, confidence rose, house prices soared, equities rose sharply and employers dusted off their fixed-investment plans.

On the run-in to subsequent MPC meetings — held every two months — speculation centred on the prospect of further rate cuts. However, the MPC kept rates steady at every meeting since August 2004, despite better-than-expected inflation data.

CPIX inflation has fallen to 3.1%. Once, this would have been a sure-fire indicator of a rate cut. Yet a rate cut seems unlikely. What’s going on?

Clues are found in the February 2005 MPC statement. The inflation prognosis looked good back then, but the Bank decided to hold firm on rates.

Five key imponderables give the Bank pause:

• Oil prices. In March, petrol prices went up by 42c a litre and last week rose by a further 40c. Further fuel price rises are likely in May. Fuel accounts for only 5% of the consumer inflation "basket", but transport costs have knock-on effects across the economy.
• Bank credit. We’ve seen 17.5% year-on-year growth in bank credit. Much of this has driven asset inflation (spending on residential property), but consumer credit (credit cards, personal loans, and overdrafts) has also started to rise strongly — another signal that the economy is not in need of further stimulation.
• Capacity utilisation. The authorities expect 4.3% GDP growth this year (against 3.7% in 2004). Retail sales were up more than 10% in 2004, after adjusting for inflation; motor vehicle sales are up 21% year-on-year in the first three months of 2005. As economic growth remains robust, capacity utilisation increases until capacity constraints emerge. For example, a brick shortage was recently experienced as production capacity became stretched. When demand grows but supply doesn’t, prices tend to rise.
• Balance of payments. Our trade account has deteriorated, with imports rising faster than exports. The shortfall has been made good by portfolio investment inflows, but global fund managers are fickle and these inflows could abate or become net outflows. This leaves the rand vulnerable.
• Global imbalances. This is code for how the US runs its economy. Its budget deficit is close to 4% of GDP while the current account deficit is 6% of GDP. In response, US authorities have increased interest rates. They’re at 2.75% and by year-end could reach 4%, closing the gap on the rest of the world. If we reduce interest rates in the face of US hikes, the gap would close faster than our authorities might like.

Some are suggesting that these "uncertainties" could induce an early rate rise. Yet the prospects for inflation are sound and the MPC is more likely to leave rates unchanged. A premature rate increase would be a slap in the face for local companies that have committed to new fixed investment programmes, creating the prospect of more jobs.

We’ve recently seen over 9% growth in fixed investment and authorities would like the trend to continue. A rate increase could bring it to a premature end, putting job creation on hold.

National planners would like to avoid the spectre of "jobless growth". A continuation of interest rate stability would help them do just that.

Lings is chief economist at Stanlib Asset Management