SARB hold only temporary
2014-03-28
SARB went back on hold, with interest rates unchanged after today's Monetary Policy Committee meeting, the prime interest rate remaining at 9%.
But this appears to be only a temporary holding pattern. Much higher interest rates will follow through at least 2016 (or even beyond), timing entirely dependent on events and projections, with SARB displaying an extreme sense of global risk for SA through the Rand.
The SARB hold on interest rates could last much deeper into 2014 if financial market stability were to be preserved for longer and the Rand's recent stability could last longer, too, together with reduced pass-through limiting the inflation breakout to 6.0-6.5% and this already discounted in present SARB interest rate levels (though not in market expectations still looking for 100 points more of rate tightening this year and another 100 points next year).
But this is no given. Every MPC meeting is an opportunity to reset all calibrations, consider future risks, refuse to fall behind in the response curve. Bear this in mind with every future meeting.
Besides the SARB's clear vigilance about higher inflation, and longer term concerns about the sustainability of present trends over the balance of payments (with its implications for downside Rand risk and upside inflation risk), the present interest rate holding pattern can clearly hold only so long.
Our SA inflation prospect remains medium-term near 6%. In addition, it is a given that the US economy is slowly normalising its output levels, with Fed policy similarly destined to normalise further once bond purchases have ended from 3Q2014.
Starting sometime in 2015, the Fed is likely to start raising its interest rates. Even if this were to progress slowly and unevenly through 2017/2018, it would still imply a short-term rate tightening of at least 2-3% during 2015-2018.
Though Europe will be late, given its very slow growth prospects, it too at some point will start to lift rates, probably within this 5 year US time horizon.
These normalising global conditions, and the pressures they will generate for global risk/reward patterns to change appropriately, with yet more currency realignments to follow, are likely to put pressure on the SARB to normalise its interest rate levels, too.
With the SARB intervention (repo) rate at 5.5% still negative in real terms, whereas more normal conditions would warrant a 2-3% real rate, there is much scope here for nominal SA rates to adjust higher in line with global adjustments, and assuming our output gap (growth) condition not to worsen further.
Assuming a 6% SA inflation rate, more normal global conditions and interest rate levels would suggest a 12.5% SA prime target with currently undershooting GDP growth limiting this to 11%.
So a base case target for SA prime through 2017 would be at least 11% prime. Any SA growth recovery from present subpar 2% levels would add to this target.
One rarely hears a case being made for lowering such prime rate targets due to regulatory constraining of credit access, with nominal credit growth already since 2008 comfortably undershooting nominal GDP, restraining any leverage intentions. This consideration, though, may remain alive at the SARB.
Once SA growth has fully recovered its potential 3.5%, with the economy at full resource potential (meaning absorbable resources fully deployed and the balance of payments not overly strained by a large current account deficit), the prime interest rate norm with inflation still 6% would be in the vicinity of 12%-13%.
That would be a standard policy target for 2016-2018, depending on how fast overseas central banks move, the pressure on the Rand and inflation, and the extent to which SA growth recovered towards potential.
If the global policy normalisation were to be accompanied by periodic market stresses due to uncertainty episodes, giving us Rand undershooting and upside inflation risk, and if the SA balance of payments were to have difficulty right-sizing (eroding the current account deficit), a further 1-2% risk premium might end up being added to the target prime interest rate for 2017-2018, taking it to 13-14%.
A major new financial crisis, either overseas or locally, could blow all these numbers much higher, as on past occasions in 1998 and 1985 due to a Rand crisis, with the target prime rate potentially reaching 18-20% for a while.
This scenario is considered to have a small probability at this stage, given what we know about overseas and local developments and prospects.
Only an exceptional inflation surprise to the downside, with SA inflation reaching anew 3-4% would have the power to lower the prime interest rate target for 2016-2018 to nearer 9-10% even with rates overseas normalising.
The likelihood of this lower prime target being achieved this decade looks very small, given the likely staying power of 5-7% SA inflation.
Cees Bruggemans
Consulting Economist
Bruggemans & Associates
Website www.bruggemans.co.za
Email economics@bruggemans.co.za
Twitter @ceesbruggemans