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Friday Jul 20, 2012

Prime rate of 8.5 percent is lowest since 1973

The Reserve Bank's 50 basis point cut in its repo rate to 5 percent took the markets by surprise yesterday.

The rate had been steady at 5.5 percent since November 2010 and, earlier this week, money market transactions were signalling only a 30 percent chance of a reduction as early as yesterday - betting higher odds on a cut later in the year.

Kevin Lings, the chief economist at Stanlib, said: "Given the change in tone and emphasis from the Reserve Bank, a further rate cut before year-end cannot be ignored."

Central bank governor Gill Marcus noted that monetary policy had been eased in a number of advanced and emerging market countries, in response to slowing growth worldwide.

In answer to a question at a press conference after the meeting of the monetary policy committee (MPC), Marcus acknowledged the decision had been taken only after a "robust debate" among MPC members.

The rand, which weakened ahead of the news to R8.2177 to the dollar by 3.15 pm, regained ground to R8.1851 at 5pm. This runs counter to the conventional view that a currency will weaken when interest rates fall because lower rates attract less money from abroad. There is a counter argument that higher growth will draw money into equities. However, local shares have not been popular with non-residents recently, while domestic bonds have attracted R60.1 billion in the year to date, and R21.7bn in June alone, according to Marcus.

Prime at 8.5 percent will be at its lowest since 1973 when it was 8 percent. As from today, households with a R1 million mortgage bond over 20 years will pay R8 678 a month, or R319 less each month. This follows a reduction of R4 542 in monthly mortgage repayments, since the peak in prime and mortgage rates of 15.5 percent in December 2008, to 9 percent in December 2010.

Absa property strategist Jacques du Toit said mortgage repayments would be nearly 36 percent lower than they were at their peak. As mortgage loans are worth R1.2 trillion - nearly half the banks' total loans of R2.3 trillion - the lower rate will ease the burden of servicing debt.

Debt service costs as a ratio of disposable household income, which had already fallen from a peak of 12.7 percent in the third quarter of 2008 to 6.7 percent in the first quarter of this year, will drop to 6.3 percent, according to Du Toit.

After the inflation rate has surprised on the downside for three consecutive months, the bank has revised down its inflation forecast for the year to 5.6 percent from the 6 percent estimate in May. And, after disappointing economic data since the last meeting, it has cut its economic growth forecast from 2.9 percent to 2.7 percent.

Marcus warned the rate cut on its own would not overcome the challenges facing the economy, but said it could "help alleviate pressures faced by some sectors".

She stressed: "A sustained increase in the potential output of the economy will require a concerted and co-ordinated effort from both government and the private sector."

Marcus said the damage from events abroad was "reinforced further by the fragile domestic private sector investment and consumption trend".

The Reserve Bank's June Quarterly Bulletin noted that growth in real gross fixed capital formation fell to 5.3 percent in the first quarter, from 7.2 percent in the fourth quarter of last year. These are quarterly changes adjusted for seasonal factors and inflation and multiplied by four to show an annual rate.

Economists have cited policy uncertainty as a major reason for weak investment by the private sector.

Business Report

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