IT SEEMS a fairly foregone conclusion that the Reserve Bank will keep interest rates steady at near-record lows for the whole of next year. Economic growth will remain sluggish, while inflation looks set to breach the upper end of its 3% to 6% official target in the next few months.
These trends offset each other, making either an interest rate cut or hike very unlikely.
Nonetheless, some analysts are betting that the Bank will weigh in with another surprise cut in interest rates at some point next year, after lowering them by seven percentage points since December 2008.
The logic is fairly simple: there is a good chance the forces which drive domestic growth will stutter while the global background remains negative, curbing appetite for local exports and assets.
The rate cut advocates also believe that the breach of the inflation target will be temporary and that the pace of consumer price increases will subside back into the official range over most of the Bank’s two-year forecast period. They maintain that if there was a big disappointment in growth, the Bank would be prepared to tolerate inflation of more than 6% — provided it is not seen as sustainable.
There are good reasons why inflation is likely to remain within its target range — one being the recent recovery in the rand, which reduces the cost of imports. If this persists, as some believe it will, one of the main risks to the inflation outlook will be neutralised.
The trouble is that the rand is hostage to swings in global appetite for risk — so if the international background improves, it will firm. Any deterioration in the eurozone’s debt crisis or US fiscal dynamics will knock the rand weaker, along with global equities and other assets perceived as "risky".
On the domestic front, South Africa’s ballooning current account deficit, its broadest measure of trade in goods and services, also weighs heavily on the volatile currency. This trend is very worrying, as the shortfall must be financed by foreign purchases of local shares and bonds — also known as "hot money". This year has seen large inflows of foreign money into the bond market, but if these should reverse, the rand will weaken.
Food prices were the other big threat to price stability highlighted at last month’s policy meeting.
The effect of a US drought on global maize prices has yet to feed through to the domestic market, but the international trend has reversed, making it unlikely that food will continue to exert upward pressure on inflation in the medium term.
Steep wage settlements have also been cited by the Bank as an inflation risk, but to a lesser extent than food and the rand’s exchange rate. Given that these have been restricted mainly to the mining sector, it seems unlikely that they will boost overall demand to push inflation higher. Household consumption, the economy’s main engine, has slowed now for three quarters in a row and its growth rate is the lowest since the 2009 recession.
Inflation expectations, often a self-fulfilling prophecy, also come into play when the Bank makes decisions on interest rates. These mitigate against a rate cut, as they edged higher during the fourth quarter of this year, according to a survey carried out by the independent Bureau for Economic Research based in Stellenbosch.
Business, trade unions and analysts now see inflation at an average of 6.1% next year and 6.2% the following year, compared with 6% and 6.2% previously.
On the face of it, this is not a big change but a breakdown of the components are interesting — the inflation expectations of trade unions have fallen while those of business people have increased substantially, to 6.6% next year and 6.7% the following year. This could reflect concern about the effects of higher wages and the rising cost of inputs such as electricity. The expectations could also stem from the perceived likelihood of higher costs in the economy generally.
So despite weaker economic growth, when the inflation background is carefully considered, it is unlikely that the Bank will trim interest rates next year.