Johannesburg, 09 Nov 2004
It is broadly held after the result of the last MPC meeting that we have reached the bottom of the interest rate cycle. While we may see some minor changes from the current level, it is highly unlikely that we will see any further substantial reductions.
Indeed, one must believe that any substantial changes can only be in the upward direction. But just how quickly can we expect rates to move from their current levels, and once this phase of the interest rate cycle commences, where can we expect rates to peak? Are we going to see an inexorable rise from these record lows?
We must first look at the rand.
With rates as low as they are, and consequentially buoyant consumer spending, SA is running a significant current account deficit. Over the medium-term this deficit would normally create pressure on the rand to weaken. But with foreign interest in SA as significant as it is - whether it is foreigners investing in the financial sector or investing into SA as a commodity play - this spending is being more than matched by capital inflows.
For this reason, the pressure exerted from the shorter-term current account deficit is being more than matched by longer-term and (traditionally) more stable capital inflows. For an example of this, look at the US current account deficit; it is currently running at over $50 billion per month and rather than this bringing a collapse in the currency, the USD is remaining relatively stable against most of the major currencies. This is not to say that the USD could not collapse but in the medium-term this has not been the case. Hence, even with significantly increased consumer spending and indeed importing, there is much room for this flow to be offset by capital investment.
Even in the event of a weakening rand, this will not immediately necessitate a rate hike. When the rand weakened dramatically in 2001, reaching a high of 13.85 to the USD, many of the importers were very quick to increase their prices to a significant degree. Since then the rand has only rallied, touching a low of just below 6 to the USD. How many of us have witnessed corresponding decreases in the price of imported goods? Importers and retailers are making `super normal profits`, which is profit far in excess of what they would normally consider to be a fair margin. In the event of a weakening of the rand, there is enough room built into the cost of imports so as to make any shock absorbable by the importers. It will not be necessary to pass the higher costs on to the consumer.
Beyond the acute inflationary driver of the rand we must look at other macro factors. Specifically we must look at inflation expectations.
The SARB has done a remarkable job of firstly containing and subsequently reducing the level of inflation in the economy. If inflation and inflationary expectations can be sustained within the 3% to 6% mandate of the SARB for a period of time, say for a further two years, then I would argue that inflation expectations of old would have fundamentally changed. Already we are seeing these lower inflation expectations manifesting themselves in the escalation clauses in rental and lease agreements - 10% escalation clauses, commonplace only two or three years ago, have now been replaced by escalation clause of around 7% to 8%. Once the expectation of a decreased inflation level has permeated throughout the community (a crucial part of the inflation cycle and process) wage negotiations will then be settled at a lower level. This process itself further reinforces the lower level of inflation.
Finally, and perhaps most significantly, a substantial influence on the interest rate level, or more accurately on the change in interest rates required in the event of an inflationary period occurring, is the level of debt that has been built up by the consumer base. With the consumer base more heavily indebted than it was only a couple of years ago, any increase in rates will have a far greater effect on the pocket of the consumer than it would have had prior to this build up of debt. Therefore the consumer should be significantly more sensitive to any increase in rates and consequent drastically higher rates will not be required to have the desired effect on consumer spending.
Overall we may be at the bottom of the interest rate cycle in SA; however, international interest rates, particularly those in the US, do not seem set to go up any time soon. Indeed the poor numbers out of the US recently would suggest that potentially a rate cut would be required. While this is not going to happen, there is certainly no `external pressure` being exerted on the SARB to raise rates.
Nevertheless eventually interest rates will rise, yet how far they will need to rise is the big question. With consumers more heavily indebted then ever before, there will be less of an interest rate rise required to achieve a slowing down of spending than in the past. Furthermore, inflation expectations are changing and will have fundamentally changed by this time. And finally, there is no external pressure requiring a rate hike.
The days of prime at 20% plus are long gone... A peak in interest rates of only 3% above current rates is what I would expect.
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