Kevin O'Grady

Economics Editor

RESERVE Bank governor Tito Mboweni stunned the markets with an interest rate cut yesterday, in a move economists said suggested a "change of heart" in the Bank’s view on the rand exchange rate.

Defying the expectations of economists and the financial markets, Mboweni said the Bank’s monetary policy committee had decided to drop the repo rate to 7% — a cut of half a percentage point.

The committee appears to have been swayed by the latest inflation expectation survey and yesterday’s weaker than expected manufacturing production figures, which point to a slowdown in a crucial sector of the economy.

The major retail banks followed suit, reducing their prime lending rates from 11% to 10,5%.

To the extent that it weakens the rand, the move will come as welcome relief to exporters, manufacturers and trade unions, who have been clamouring for intervention against the strong currency.

Announcing the surprise decision, Mboweni dismissed suggestions that it implied a shift away from the Bank’s inflation-targeting policy towards targeting the rand or economic growth.

Mboweni said the inflation expectation survey, conducted for the Bank by the Bureau for Economic Research at Stellenbosch University, showed that CPIX expectations had "reached their lowest level since the bureau started the survey in 2000".

"You have significant room to manoeuvre when you have inflation under control," Mboweni said.

"Central banks throughout the world have to take cognisance of overall developments in the economy, otherwise they miss the boat. They start to become states within a state," he said.

"This isn’t inflation targeting for its own sake, it’s for the better performance of the economy."

He said the committee had taken note of a "slackening in activity in some sectors of the economy as a result of the move by the rand to a higher trading range over the past six months".

The committee was of the view that a "competitive and stable exchange rate would contribute to continuing stable growth in output and employment," Mboweni said.

According to the Bank’s central inflation forecast, CPIX would rise moderately from the record 3,1% in February to about 5,2% early next year "before resuming a downward trajectory" towards the mid-point of the 3%-6% inflation target range.

Of "particular significance" was the fact that services inflation had continued its downward trend, partly reflecting "progress made by the public authorities in curbing administered price increases".

"Even taking account of the impact of the recent rise in oil prices", CPIX inflation was expected to remain comfortably within the target range for the next two years, Mboweni said.

Economists and market traders, who had almost unanimously predicted no change in rates in the light of higher oil prices, strong consumer demand and the volatile rand, were taken by surprise.

Some questioned whether the committee had made the right call in the light of the potential threats to inflation, most of which had not changed significantly since the committee kept rates on hold at its last meeting in February.

"Analysing economic events between the February meeting … and today’s decision to cut, we would conclude that the key inflation risk factors have probably heightened rather than lessened, calling for continued prudence," said Standard Bank economist Monica Ambrosi.

"The timing of the rate cut, when the outlook for oil prices and the exchange rate remains mixed and more uncertain than in previous months, is curious," she said.

Nedbank’s economics team said in a research note that the mention of the slowdown in manufacturing was "surprising and suggests a possible change of heart on the Bank’s exchange rate view, which up until now was generally that the market knew best".

Brait economist Colen Garrow said a significantly weaker rand would be good for the production side of the economy. However, the "two-pronged" erosion of the interest differential between SA and the US, could also "weigh against the rand and targeted prices to the extent that today’s interest rate cut could be quickly reversed".

Efficient Group economist Nico Kelder said the decision to cut rates was "a brave one", but the surprise cut last August "taught us that sometimes the governor’s crystal ball is in better working condition than ours".