SA rate cuts no sure thing, even as economy contracts

South Africa’s deepest quarterly economic contraction in a decade won’t automatically move the Reserve Bank to cut its key interest rate because this may drag down the country’s potential growth rate.

The difference between potential growth and actual expansion is one of the four elements in the central bank’s quarterly projection model. This gap has largely been negative since 2014 and won’t close in the next two years, according to central bank forecasts.

“If the output gap is negative, like what we have now, it could suggest to you that monetary policy should be accommodative,” Governor Lesetja Kganyago said in an interview Tuesday in Pretoria, the capital. The first quarter’s 3.2% annualized contraction might bring down potential growth, which would narrow the gap, he said.

When the Reserve Bank kept its key interest rate on hold last month, the Monetary Policy Committee’s statement – read by Kganyago – suggested some bias toward easing, with two of five MPC members favouring a cut. The last time any MPC member voted for lower rates was in March 2018.

After the release of the gross domestic product figures, forward-rate agreements, used to speculate on borrowing costs, slumped and contracts due in July are pricing in a quarter-point decrease at the next monetary-policy meeting. The central bank’s model currently predicts one 25 basis-point cut by the first quarter of next year.

“If we were to mechanically follow the quarterly projection model, we will just wait until the first quarter of next year and when it arrives, we will cut by 25 basis points,” Kganyago said. “But we might get to September and the variables had moved and the quarterly projection model might spew something else, it might even say ‘cut by 50 basis points’ or it might say ‘keep the rate the same’.”

Reserve Bank mandate

The central bank targets inflation in a range of 3% to 6% and the rate has been inside this band for more than two years. The bank’s mandate – enshrined in the Constitution – is to pursue price stability “in the interest of balanced and sustainable growth”. However, labour unions and political parties have over the years called on the institution to do more to support expansion and cut the 28% jobless rate.

Later on Tuesday, the ruling African National Congress said it would push for changes to the mandate, so that it includes growth and unemployment.

“Price stability is a necessary condition for balanced and sustainable growth, but it is by no means a sufficient condition,” Kganyago said before the ANC’s announcement. “You have other things that have got to be brought to bear to get growth going,” such as removing structural constraints, he said.