beyondbrics

To many observers, the question of whether South Africa’s Reserve Bank would cut interest rates on Thursday looked like a no-brainer. At 3.2 per cent in September, consumer price inflation is scraping the bottom of the bank’s 3-6 per cent target zone; the bank has come under mounting pressure to weaken the rand, which is at its strongest in nearly three years; and the economy is continuing to drag its feet in the recovery from last year’s recession. Yet the monetary policy committee’s decision to cut base rates by 50 basis points, to 5.5 per cent, was not a foregone conclusion.

For one thing, some recent data have suggested that the economy may be starting to gather steam. The day before the interest rate announcement, figures were released showing that retail sales had an annual rise of 6.1 per cent in September, up from 4.6 per cent the previous month. The day before that, a study released by First National Bank showed that consumer confidence was at exceptionally high levels.

As far as the rand is concerned – the currency’s rise past the R7/$ mark has sparked alarm among trade unions and exporters – Gill Marcus, the bank’s governor, has voiced reluctance to use rate cuts to curb its ascent. The main cause of the rand’s current strength is record inflows into South Africa’s high-yielding bond market from rich-world­­­ investors, who are unlikely to be deterred by today’s move.

Marcus’s caution around rate cuts reflects the institutional memory of the Reserve Bank, which remembers all too well the struggles of much of the last decade, when it battled to bring inflation below 10 per cent. Given the time it takes for interest rate moves to have their impact on the economy, it may still be too early to gauge the full effect of the 600 basis points that have been slashed from base rates since the start of last year. Any inflationary pressures unleashed by another rate cut might not become apparent until too late.

Yet the threat of high inflation has rarely seemed so distant in South Africa’s recent history – indeed, Marcus’s explanatory comments suggested the MPC was concerned about the consequences of inflation dipping too far below the 3 per cent minimum target. “Domestic economic growth remains fragile,” she added, voicing concern about possible fallout from a revival of troubles in Europe, as Ireland considers an emergency loan package from the EU. The big retail banks immediately announced cuts in their lending rates following the announcement, encouraging hopes that the rate cut will boost borrowing.

But the move may have unforeseen consequences, said Peter Attard Montalto of Nomura International. “We think the MPC is being overly dovish and the risks of policy mistake are high,” he said.

“A strategy and trend of continually cutting on a weak growth outlook and inflation in target and not near the top of the band risk a bond market expectation cycle of more and more cuts, causing bond buying, inflows and a strengthening currency which will cause further falls in the SARB’s inflation forecast and hence opens up the possibility of more rate cuts.”

It may have brought South African interest rates to their lowest level for 30 years – but having started cutting, the Reserve Bank could find it hard to stop.