BANK ON IT:  Inflation is on target, says Reserve Bank governor Lesetja Kganyago, seen here taking over from Gill Marcus in October 2014 Picture: GALLO IMAGES
BANK ON IT: Inflation is on target, says Reserve Bank governor Lesetja Kganyago, seen here taking over from Gill Marcus in October 2014 Picture: GALLO IMAGES

IT might be left to the South African Reserve Bank to stimulate the ailing economy with interest rate cuts after shock GDP figures showed a slump in consumer spending, signalling that the economy requires urgent intervention.

The central bank's mandate is to achieve and maintain price stability through inflation targeting.

Although monetary policy cannot contribute directly to economic growth and job creation in the long run, economists say that in the face of recession and the lack of capacity in the public sector to drive economic growth, the Reserve Bank will have to cut interest rates as early as next month to boost consumption, a major component of GDP.

Johann Els, senior economist at Old Mutual Investment Group, said this week that the Reserve Bank's monetary policy committee "need to cut soon while they have a window of opportunity - this being a strong rand, lower inflation, a weak economy, a low current account deficit and a rating reprieve for the next six to 12 months".

If the Reserve Bank decided to cut rates in July by 25 basis points, it would lift sentiment even if it did not necessarily produce a significant boost to the economy, Els said.

An interest rate cut would take some time to filter through to the real economy. "However, cuts will help the growth outlook down the line, which should please the ratings agencies and investors."

South Africa's credit rating has been downgraded by three agencies. Fitch and S&P Global Ratings (with the exception of the local currency rating) now rate South Africa as junk, while Moody's still has South Africa at investment grade.

The last time the Reserve Bank lowered interest rates was in July 2012, cutting the repo rate by 50 basis points to 5%. Since January 2014 it has hiked rates by 200 basis points.

Graphic: RUBY-GAY MARTIN
Graphic: RUBY-GAY MARTIN

Inflation outcomes in March and April surprised on the downside, Reserve Bank governor Lesetja Kganyago said in May, adding that inflation was expected to remain within the target range at 5.7% for 2017. Global inflation remains relatively benign.

John Ashbourne, Africa economist at Capital Economics, said: "Very conveniently inflation is easing across the economy, so the Reserve Bank is in the enviable position of having the policy space needed to step in and support the economy."

Nazmeera Moola, co-head of fixed income at Investec Asset Management, said: "The expected plunge in inflation was always going to put pressure on the [Reserve Bank] to cut rates by 25 to 50 basis points in 2017."

Despite the Reserve Bank's concern over the impact of politics on the rand and inflation, "the widespread weakness in the domestic economy could spur a cut as early as July. The economy is just that weak," she said.

Lacklustre household and business confidence is expected, leading to tepid economic growth of below 1% for 2017. Household consumption expenditure contracted 2.3% in the first quarter. Middle-income earners face the most pressure. Growth in household net wealth has dwindled to just under 6% in 2016 from 17.2% in 2014, according to Momentum Investments.

Business confidence has plunged to its worst levels since the 2008-09 recession, according to a Rand Merchant Bank/ Bureau for Economic Research survey published on Wednesday.

Last week, worse-than-expected mining figures showed a plunge in output to 1.7% in April - the worst since mid-2014 - from 15.4% previously, stoking fears of poor second-quarter growth.

Manufacturing and retail sales continued to fall at the start of the second quarter but the rate of contraction eased in both sectors. Retail sales rose by 1.5% year on year in April from 0.9% in March, StatsSA said on Wednesday. The performance was weak by historical standards. The improvements were the result of growth in supermarket sales.

The rand has held steady despite the weaker economy, trading at just under R13 to the dollar this week.

Azar Jammine, chief economist at Econometrix, said that at least three-quarters of the rand's strength over the past few years was a factor of carry trade - which occurs when an investor sells a certain currency with a relatively low interest rate and uses the funds to buy a different currency yielding a higher interest rate.

But carry trade was also happening because global risk appetite was positive amid perceptions that the world economy was faring better, and this in turn supported commodity prices, which had enhanced South Africa's trade balance over the past two years. "Arguably that has been at the heart of the strengthening of the rand," Jammine said.

The rand is the third-best currency performer since the beginning of the year after the Mexican peso and Polish zloty, delivering 13.33% in returns. On Wednesday afternoon the rand was trading 8.15% stronger against the dollar since the start of the year.

But whether the Reserve Bank does cut rates will depend in part on the US Federal Reserve.

An interest rates hike in the US this week could lead to significant capital outflows and rand weakness, which could stoke inflation.

The Fed raised rates in March for the second time in three months, but the prospect of a steep rate hike cycle is uncertain.

The Fed is expected to hike rates again this year but not as steeply as previously expected.

Jammine said capital inflows would continue to support riskier assets as investors were able to absorb more risk. Central banks worldwide continued to pump excess amounts of capital into the global monetary system, he said.

A hike in US interest rates had been expected for months and priced in to the currency already, Jammine said. And coupled with expected capital inflows into emerging markets the rand was likely to remain stable.

"I don't know that just an interest rate increase [by the Fed] that has been spoken about for so long is going to be the catalyst for change" and undermine the cause for a rate cut in South Africa, he said.

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