September 2019 Economic Commentary
Global central banks still cutting rates amid weak global growth and low inflation.
Political uncertainty is also on the rise on both sides of the Atlantic.
South African Reserve Bank did not join its peers in cutting, but a November cut is still on the cards.
The global interest rate cutting cycle is still very much underway. September saw 19 central banks cut rates, while four hiked. Among those reducing rates were the world’s two most significant central banks, the US Federal Reserve (the Fed) and the European Central Bank (ECB).
After the 25 basis points cut, its policy interest rate, the federal funds rate, now sits in a range of 1.75 to 2%. The path forward is less clear. Fed Chair Jerome Powell was at pains to argue that they still saw the US economy as being in good shape, led by strong consumer spending on the back of a healthy labour market. However, persistently weak inflation and the uncertainty generated by a weak global economy and President Donald Trump’s trade wars resulted in a second consecutive rate cut. Political uncertainty is also set to increase following the announcement that Trump faces an impeachment inquiry in Congress for seeking Ukrainian assistance in undermining a potential rival in next year’s presidential election. In other worlds, rather than responding to weakness in the US economy, the Fed is recalibrating its interest rate stance to better reflect the risks. Powell and his colleagues also reiterated that they were ready to act as needed to sustain the US economic expansion, now in its eleventh year. Further cuts could follow if needed, but the Fed is careful to avoid the perception that it will necessarily reduce rates. It is a tricky balancing act.
The ECB cut its deposit rate cut by 10 basis points to -0.5% and re-launched a €20 billion monthly bond buying (quantitative easing, or QE) programme. It also introduced a tiered system to avoid the negative impact of sub-zero rates on banks. Notably, for the first time, the ECB said it will maintain QE and negative interest rates until such time as inflation “robustly” converges on its 2% target. Both negative rates and QE are now open-ended. Whether this will help the struggling Eurozone economy is another matter. If negative interest rates did not spur economic activity up to now, slightly more negative rates are unlikely to do the trick in the future. On the QE side, the problem is that the ECB could run out of bonds to buy within a year, since the largest economy in the bloc, Germany, runs a budget surplus and therefore the outstanding stock of German bonds is declining. This has not gone unnoticed at the ECB. Both Mario Draghi and his successor as ECB President, Christine Lagarde, have called on easier fiscal policy (more spending by governments) to do the heavy lifting of preventing a recession in the Eurozone.
Two notable central banks that kept rates on hold during the month were the Bank of Japan (whose rates are already negative) and the Bank of England. The BoE is trapped by Brexit, since the economy would need stimulus in the event no-deal or “hard” Brexit, but the weakness in the pound has resulted above-target inflation.
The Brexit uncertainty has not gone away and Boris Johnson’s short stint as Prime Minister has seen one setback after another. First Parliament voted to block a no-deal or “hard” Brexit - the UK crashing out of the European Union without an agreement on the future economic relationship. Johnson has argued that he needs the threat of a hard Brexit as a bargaining chip to get concessions from European leaders. Parliament also voted to prevent Johnson from calling an early election. Last week the UK’s Supreme Court ruled that Johnson’s earlier five- week suspension of Parliament was until next month was unlawful. The next important milestone is a gathering of European leaders in mid-October. Parliament has legislated that the Prime Minister must request an extension of the 31 October deadline if no Brexit deal is agreed at that summit. An election is likely to follow, dragging out uncertainty not only over the UK’s future status in Europe, but also who would be responsible for negotiating it.
Local consumer inflation was a little higher than expected in August, but at 4.3% remains below the midpoint of the 3% to 6% target range. The SA Reserve Bank also expects it to remain within the target range over the next two years.
The economy performed better than expected in the second quarter with a 3.1% quarter-on- quarter bounce after contracting in the first quarter. However, there is no indication that this strong upward momentum will be sustained. In fact, business confidence fell to a 20-year low in the third quarter according to the BER’s long-running survey. The underlying growth picture is still gloomy and the SARB expects growth of 0.6% this year and only 1.5% next year (the previous forecast was 1.8%).
The jump in the oil price following attacks on Saudi Arabian oil facilities by Yemeni rebels largely reversed itself as it appears the damage can be repaired fairly quickly. However, this does introduce a new element of uncertainty to the thinking of the SARB and other policymakers.
Fiscal risks are also an element of uncertainty. The Medium Term Budget Policy Statement in late October will present an update on government’s expanded borrowing requirement. Moody’s are scheduled to announce a ratings decision on the first of November. They have largely (but not completely) ruled out a downgrade, but a change in outlook from stable to negative is likely. If any of these events turn out differently to what the market expects, the result could be a sell- off in the rand and local bonds. By the same token, a better-than-expected result could see a rally in bonds.
Faced with this long list of ifs, buts and maybes, the conservative Reserve Bank kept the repo rate unchanged at 6.5%, which means the prime overdraft rate of banks remained at 10%. The 21 November meeting is a more likely candidate for a rate cut. By keeping firm while other central banks are cutting, the SARB is ensuring that local rates remain among the highest of any major economy.