Why SARB needs Goldilocks for rate cut to work


Cape Town - The SA Reserve Bank (SARB) needs a Goldilocks scenario in the medium term for its 25 basis points repo rate cut of last week to be "OK", according to emerging markets economist Peter Attard Montalto of Nomura.

A Goldilocks economy is not so hot that it causes inflation, while not so cold that it causes a recession. It is characterised by low inflation, a low unemployment rate, increasing asset prices, low interest rates and brisk but steady gross domestic product (GDP) growth, according to Investopedia.

Montalto pointed out that the SARB has always stressed that monetary policy acts over an 18 month plus time horizon. He also pointed out that the surprise 25bp cut caused fracturing of a previously cohesive Monetary Policy Committee (MPC) to a 4-2 vote.

READ: Surprise cut in SA interest rates, rand hit

"Further ratings actions and the significant likelihood of falling out of the World Government Bond Index (WGBI) next year that are in our baseline, may well make this cut look imprudent at that point," said Montalto.

In his view, the rand will not necessarily do too badly in the short term.

"However, if monetary policy does indeed act mainly over a long horizon, we see little point in ‘fiddling’ with a cut (last week), especially in the current political environment. The SARB could have waited for more certainty at the end of November on ratings for instance, or signal a cut today and act in September after the GDP data or January after the elective conference," said Montalto.

"These points could then have provided more forward guidance on future cuts at the time than they could today, which could be important for and made monetary policy transmission more effective. As a result, there is much head-scratching and lack of meaningful forward guidance. Indeed, the risks to hikes next year are meaningful if there is an index event and would compound issues around this cut and ones to come."

Another cut

Montalto will be looking for another 25bp cut this year - more likely in September than November - but added it would be highly data-dependent. Regarding decisions by the MPC in 2018, he said it would be dependent on the results of the ANC elective conference.

"We have long laid out the path to cuts for the MPC as being around when long-term inflation was more closely anchored within target within its forecast, and we specifically highlighted that CPI forecasts below 5.0% would be the key," said Montalto.

"The surprise (of Thursday's rate cut) is more that this hurdle has been crossed so fast since the last meeting with such big forecast changes, more maybe than the cut itself."

In his opinion, the latest inflation expectations data that saw long-term levels rise even as shorter ones fall was not a major factor in driving Thursday's cut.

"The SARB was clear that it still views them as not sufficiently anchored and one key line in the statement was that it is still uncomfortable with expectations," said Montalto.

"We pencil-in rates of 6.50% for end-2017 and then flat through end-2019, but highlight the risks are to hikes and cuts next year depending on political outcome."

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