Published: 20 July 2017

Johannesburg - Ahead of the Monetary Policy Committee's (MPC) rate announcement, research analyst at Credit Suisse Carlos Teixeira unpacks four reasons why the Reserve Bank should consider a rate cut.

According to Fin24, data from Statistics South Africa (Stats SA) shows that inflation for June eased to 5.1%.

The lower inflation and recessionary conditions are expected to prompt monetary policy easing, however this is counteracted by the persistent currency risk linked to political uncertainty and the normalising of interest rates by the Federal Reserve Bank in the US, analysts said.

In a report issued earlier this week, Investec chief economist Annabel Bishop said that although the Reserve Bank has reached the end of the hiking cycle, it may hold off on a rate cut. The Reserve Bank is expected to take a dovish stance for the second half of the year.

But in a report Teixeira explained that given the outlook for Consumer Price Index inflation and economic growth, monetary policy easing is warranted. Inflation is expected to remain below 5% for the remainder of 2017 and the first half of 2018, and it is expected to be below 5.5% during the second half of 2018.  

Credit Suisse considered the monetary conditions, the risk exposure of the rand and the Taylor Rule to justify its reasoning.

Tightening monetary conditions

Monetary conditions have tightened steadily since January 2016, he said. “Real long interest rates, real short interest rates and the real effective exchange rate of the rand have all increased.”

Real short interest rates and the real effective exchange rate particularly have been at multiyear highs. While monetary conditions have tightened, inflation has neared two year lows and GDP growth has reached eight-year lows.

Nominal and real interest rate differentials

The interest rate differentials to US rates are close to multi-year highs, said Teixeira. For example, both the nominal three-month Treasury bill rate differential and the real differential are at seven-year highs.

Inflation and output 'gaps' to persist

The inflation and output 'gaps' look likely to persist throughout 2018, said Teixeira. Using the Taylor Rule, a proposed guideline as to how central banks should adjust interest rates considering changes in economic conditions, Credit Suisse has determined there is scope to cut interest rates by 50 basis points.

Inflation could withstand currency weakness

The inflation forecast indicates it could withstand possible emerging currency weaknesses. "We acknowledge that recent developments regarding the Reserve Bank's mandate and the continued risk of further credit downgrades are of concern, but the risk of a renewed contraction in GDP is also high," he said. 
- fin24