Some light at the end of the tunnel
Rodney Hayter

CAPE TOWN (September 10) - The Reserve Bank’s decision to hold interest rates at its August bi-monthly meeting suggests that we have reached the peak and that rates will start coming down from next year.

The move has drawn an almost audible sigh of relief from the latest Pam Golding Properties Intellectual Properties, who were quick of the mark in pronouncing it “good news for the housing market!”

This time, according to an article in the magazine, the Reserve Bank has ignored those diehards urging it to continue with raising interest rates – which so far has been the chosen weapon with which to try to stem the inflationary spiral. The Bank’s monetary policy committee, chaired by the governor, Tito Mboweni, decided to listen to the clamour of protest from hard-pressed consumers and take cognisance of our sliding economy.

Thus the bank’s repo rate (at which commercial banks borrow money at the RB’s “window”) remains at 12% and the prime and mortgage lending rate from the banks stays at 15,5%. What a relief! And it’s good news for the housing market.

But why has the Reserve Bank ostensibly taken a different line? One reason is that the committee’s inflation targeting policy, which to all intents and purposes isn’t working too well, attempts to look ahead and not to the short term. Moreover, monetary policy over the short term has a limited impact on the economy. So the committee has been assessing the inflation outlook, as it sees it, next year and the next. And the signs look encouraging.

Mboweni announced that the bank expects inflation to be down significantly in the first quarter of next year and that the inflation rate should creep down within the target level of 3%–6% by 2010 – just in time for the Soccer World Cup!

There are a number of reasons. The major one is technical in that the re-basing exercise, and the new basket of consumer goods and their weighting in the basket which Stats SA will use to calculate CPIX (consumer inflation without mortgages), could result in a 2% reduction in CPIX next year, perhaps even 3%, and that the inflation rate will average 5,9% in 2010.

Many economists consider this a “benign” view of the inflation outlook since it hinges on a number of imponderables, such as the international oil price, which has dropped considerably in recent weeks, food prices and – a looming danger – domestic wage demands. Double-digit wage settlements have begun to emerge which dilute the impact of tighter monetary policy as additional money is injected to support aggregate demand. Also, increases in administered prices are anticipated later this year, which will affect the RB’s inflation scenario.

But to continue raising interest rates was apparently unpalatable given the fact the economy is in a severe downswing with growth in retail sales, vehicle sales and house prices all in negative territory.

The big question now is whether the interest rates pattern will turn. Mboweni did not suggest this, saying simply that the monetary policy committee will remain “vigilant and do what’s necessary in the future”. But a number of respected economists now suggest that rate cuts are definitely on the cards.

This, if the case, is wonderful news for householders and the residential property market. Bondholders have experienced a 35,6% increase in mortgage repayments since June 2006, when the bank commenced hiking rates.
First National Bank’s chief economist Cees Bruggemans thinks relief could come as early as December 11, when the monetary policy committee meets again (but we’ll have a better indication of the trend after its next meeting on October 9). Bruggemans predicts that rates will fall steadily, resulting in the prime rate at 13% by the second half of next year.

Standard Bank’s chief economist Goolam Ballim also predicts cuts, but only in the second quarter of next year, and Investec’s Annabel Bishop reckons cuts will only be likely by April next year.

In a general sense, the current situation must surely bring inflation targeting and the mechanism of solely raising interest rates to combat inflation under scrutiny. The exercise of targeting on an inflexible basis just doesn’t seem to work – here or anywhere else for that matter. According to Annabel Bishop, Turkey’s inflation is running at 12,1% against a target of 4% to 5% and Iceland has inflation of 13,6% against a target of 2,5%.

Many analysts reckon that we would be better targeting the growth in money supply, in that a significant decline in M3 money supply would support the argument for refraining from raising interest rates. Growth in money supply is still exceptionally high in relation to economic growth, which pressures the Reserve Bank to continue to raise interest rates.

Britain’s Margaret Thatcher faced a similar dilemma in the early 80s when she faced out-of-control inflation, rising unemployment and a weakening pound. Her chancellor, Geoffrey Howe, adopted the monetarist view that fiercely curtailing money supply was the answer, and this was adopted in the famous Budget of 1981 – to the howls of disapproval of the Establishment. The article recalls that Thatcher received letters of protest from no less than 354 economists who warned that the Budget proposals would wreck the British economy.

As history records, the ’81 Budget turned the tide – an amazing victory for Howe and the Iron Lady.

Article by: Rodney Hayter -