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Tuesday Aug 23, 2011

Interest rate cuts back on table

After months of speculation about the start of the rate hiking cycle, rate cuts are back on the table. And economists are putting deflation - falling prices - back on their worry lists.

Global growth prospects have deteriorated over the past weeks and the money market has started to bet on a rate cut by the end of the year.

Ian Cruickshanks, the head of strategic research at Nedbank, said yesterday forward rate agreements (FRAs) were signalling a 40 percent chance of a half percentage point cut three months down the line - "possibly co-inciding with the November MPC (monetary policy committee) meeting".

FRAs are contracts that run for three months, starting at some point in the future.

Russell Lamberti, a strategist at ETM, described a cut as "a definite possibility" but suggested it would only happen next year, when inflation moderated. He added that ETM had been bearish on growth for some time, expecting gross domestic product (GDP) to expand between 2 percent and 2.5 percent this year. This compares with the 3.4 percent estimate in the February budget and the Reserve Bank's recent forecast of 3.7 percent.

Colen Garrow, the economist at Brait, has also been bearish on the outlook with a forecast of 2.8 percent. "In an environment such as the one we are in now, inflation will probably take care of itself," he said. "Deflation normally follows crises like these. The 'R' word is sufficient reason to underpin the economy with further interest rate relief."

Deflation is associated with a recession or even a depression because businesses are unable to make profits and are forced to cut back on staff.

Other economists are preparing to revise earlier forecasts after the events of the past few weeks. Last week, fears about global growth prospects and the stability of financial markets caused a stampede out of equities into gold, which has become a barometer of market uncertainty. Spot gold hit a record high yesterday of $1 894.80 (R13 503.40) an ounce - from $1 487 at the start of last month.

The Reserve Bank's official repo rate has been at a 30-year low of 5.5 percent since November, after retreating from a peak of 12 percent in December 2008.

The MPC will meet next month to decide whether to make another move. It said earlier this year inflation would temporarily breach the ceiling of its 3 percent to 6 percent target range at the end of the year. And economists have been expecting remedial action.

However, recent threats to the global recovery have changed the outlook for both growth and inflation.

According to Garrow, the chances of a rate cut are rising and poor numbers for second quarter GDP could prove a tipping point. Statistics SA will release the GDP data next week.

Elna Moolman, the chief South Africa economist at Renaissance Capital, saw a 15 percent probability of a rate cut. "But it would require a further deterioration of the global and domestic growth outlooks from the already subdued prognosis," she added. She is expecting the first hike in March "at the earliest".

Business Report


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