An Unexpected South African Rate Cut With a Lesson for the Euro

March 25, 2010

The South African Reserve Bank (SARB) cut its repo rate to 6.5% from 7.0% in a move that was not foreseen by analysts.  Since the prior rate hike last August, which also was by 50 basis points, the central bank’s monetary policy committee had met four times — in September, October, November and January — without changing policy, and economic recovery had become more assured with GDP rising in the fourth quarter by 3.2% at an annualized pace.  CPI inflation meanwhile only slid below its 3-6% target ceiling in the latest February report, reaching 5.7%.  Today’s rate cut augments reductions of 50 bps in December 2008, 100 bps each in February, March, April and May of last year and the aforementioned 50 bps in August 2009 to bring the cumulative drop to 550 bps from a peak of 12%.

A statement from SARB reveals that appreciation in the rand played an important role in today’s decision.  Since the prior policy meeting, the rand had advanced 3.4% against the dollar, about 8% against the euro and around 11% against sterling.  The rand is more than 33% stronger against the dollar than a year ago, and the statement candidly states that excessive rand strength had become a source for concern.  There’s a broader message in this thinking for Europe and the United States.  The euro’s recent difficulties have been spun as a problem for Euroland.  Remember, however, that former U.S. Treasury Secretary Connolly famously told his European counterparts, “the dollar is our currency but your problem” not when the U.S. currency was appreciating but rather when it was floundering.  Global economic conditions are less inflation-prone now than in 1971 when Connolly said that remark, so the risks from a depreciation of the euro are smaller than what the U.S. faced from a weaker dollar in 1971.  And for a commodity-sensitive currency like the rand, the advantages of appreciation now are outweighed by the the cost of eroded competitiveness.  Remember, too, that Norway’s central bank announced yesterday that future rate increases by it are likely to occur later than previously implied largely because of the repurcussions of a strengthening krone.  Finally, the only currency remarks heard in the halls of Washington these days are complaints about the undervalued Chinese yuan, not glee that the dollar is recouping ground against the euro.  Currency traders tend to view currency movements in a sports metaphor where rising is good and falling is bad.  From a macroeconomic policy standpoint, that is not always the case.

Growth and inflation prospects also justified today’s action.  SARB officials are projecting economic growth of 2.6% in 2010, which though clearly denoting recovery would be historically slow.  CPI inflation is expected to lie within target in both 2010 and 2011 at 5.3% and 5.4%, respectively.  A survey of private attitudes toward inflation showed a drop of about a percentage point between forecast CPI in a survey taken last autumn and a subsequent survey done recently.  It is noted that oil prices have been steady lately, food prices are better behaved, and wage pressures have lessened.  South Africa continues to have a sky-high 24.3% unemployment rate.  A current account deficit equal to 2.8% of GDP is manageable.  In conclusion, officials felt that a little more monetary stimulus would not prevent in-target inflation and would provide some welcome extra support to make the recovery more sustainable.  The dollar was left open for either a cut or hike when rates are changed next, saying that developments would be assessed continually and policy adjustments made when needed.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.

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