Comment on interest rate prospects, by Cees Bruggemans

JOHANNESBURG (February 05) - The SARB cut interest rates by 1% today, prime falling to 14%, with more easing clearly ahead.

The SARB Governor indicated, possibly only half in jest that he had proposed a 2% rate cut today, but that the Monetary Policy Committee had restrained him, feeling 1% was enough.

However, as an indication of things to come, this probably can be taken as a broad hint that the April decision will also favour another 1% cut, prime by then moving down to 13%.

The SARB Governor spent considerable time in the Q&A session following the MPC announcement dwelling on the terrible and still deteriorating condition of the world economy, explaining to the watching nation at some length that we are not isolated or decoupled from these global realities.

If your trade partners are going down, and so many are already in deep recession, one must accept that one’s own exporters are going to struggle, indeed severely so. This implies output, income and employment losses to come.

With inflation already nearly halfway down at 9,5% from its 13,6% August peak, and poised to drop within the 3%-6% target by 3Q2009, if not sooner, and with global inflation trends and our own weakening economy all reinforcing the inflation decline in coming quarters, there is clear scope for further interest rate easing.

I expect the SARB now to lower interest rates by 450 points, peak to trough, prime moving from 15,5% to 15% in December 2008, to 14% this week, to 13% by April 2009 and to 12% by June 2009.

Thereafter, depending on global and local circumstances and the inflation forecast flowing from it, and taking due cognisance of any upside inflation risks (Rand, oil, food, politicians) there could still follow further 0,5% cuts in two subsequent MPC meetings, prime falling to 11,5% in August 2009 and possible to 11% in October 2009.

Thereafter one would expect prime to go on hold through much of 2010.

It is perhaps worthwhile pointing out that these levels of interest rates should not be compared one-for-one with the cutting cycle prevailing in 2002-2004.

For South African banks are currently charging higher premiums for scarce liquidity, and this means increasing effective interest rates to most new customers, including the most creditworthy.

These actions have probably added as much as 1% to 2% to average interest rates charged on new credit lending in recent months and this should continue to apply throughout 2009 and possible 2010.

Thus the more generous interest rate decline now foreseen, discounting a prime of 11% by 4Q2009 should be tempered somewhat by the realisation that new borrowings will attract higher interest premiums which should have a constraining effect on the appetite for such new borrowings.

Just as the old 50 has become 60, if not 70, in aging terms, so an 11% prime ahead of us will still feel like 12% or more for new borrowers. The implication is less of an explosive borrowing effect eventually and all that implies for spending, growth, imports and trade data, and inflation going forward, and also for currency risk.

Cees Bruggemans is Chief Economist of First National Bank.

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