EDITORIAL: Reserve Bank’s cautious rate cut likely to underwhelm

After the drama about its role and leadership in recent months, the focus is back on the Reserve Bank’s day job.

And the interest rate decision due on Thursday will probably be among its easiest with a cut of 25 basis points virtually assured. There are some analysts arguing for a 50-basis-point cut, though they are a small minority. It would be the first reduction since March 2018.

Unlike the Bank’s decision to tighten policy in November 2018, this one won’t be controversial.

The arguments for a reduction in rates, based on both local and external factors, are compelling enough. Inflation outcomes have been lower than the Bank anticipated in 2018, with consumer inflation at, or lower than, the midpoint of the 3%-6% target every month since December 2018. Its inflation forecasts will most likely be revised lower this week.

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The rand has averaged about R14.41/$ since the last monetary policy committee (MPC) statement on May 23 and was at R13.92/$ on Tuesday, about 7% stronger than the R14.99/$ it reached on June 6, the weakest point after the last MPC meeting.

Brent crude, another source of imported inflation that the Bank watches closely, has been largely stable at a little over $60 a barrel.

Developments globally should keep these forecasts under control, not least data this week showing that the Chinese economy grew in the second quarter at the slowest pace since current records began in 1992 — even though at 6.2% it is at levels that we can only dream about.

Minutes of the European Central Bank’s (ECB) latest policy meeting, released this week, made it clear that “heightened uncertainty” about the economy of the eurozone meant that ECB officials felt they should be “ready and prepared” for a new round of stimulus.

This was in line with outgoing ECB president Mario Draghi’s comments in June, which signalled that “lingering risks” to the inflation outlook — to the downside — had strengthened the case for more action.

Those comments pushed yields in some European bond markets deeper below zero, prompting investors to look for returns elsewhere, including SA, which has been one of the factors supporting the rand and local bonds. Money markets signal that a rate cut is coming, either in July or in September.

The Federal Reserve will be deciding on US interest rates on July 31, and the futures market suggests a better than 50-50 chance of a cut, the New York Times reported this week. One of the US’s big-name investment banks, Morgan Stanley, sees Fed chair Jerome Powell and his colleagues slashing rates by 50 basis points, according to Bloomberg. Deutsche Bank sees a cut half that amount in July, but followed by 50 basis points during the rest of 2019.

While in the May statement the bank noted the dovish turn among its global counterparts, that came with a word of caution as “the risk of a renewed tightening of financial conditions should not be underestimated”.

That line probably won’t be repeated on Thursday.

Lower interest rates globally will give the Bank the space to cut without being overly concerned about the rate differential working against local assets and weakening the rand.

The interesting debate will be about how deep policymakers should go. There is a school of thought that says the Bank erred when it increased the repo rate in November. With conditions having changed to support a dovish stance, a mere reversal of the 25-basis-point hike will in reality not amount to loosening and the Bank should then go all the way and deliver 50 basis points, so the argument goes.

This is unlikely. While inflation is at the midpoint of the target, the Bank will want to ensure that it stays around there on a more consistent level. An aggressive cut now would threaten what it has achieved so far and might see inflation expectations edge higher.

So expect a cautious Bank to deliver the minimum — and that may leave some disappointed.