The recent announcement that South Africa has officially entered a technical recession – characterised by two consecutive quarters of negative GDP growth – indicates that the South African Reserve Bank (SARB) has fallen behind the curve when it comes to interest rate cuts.
This is according to Johann Els, Senior Economist at Old Mutual Investment Group, who says that, while his team had previously anticipated one rate cut in 2017, despite the recent Cabinet reshuffle and sovereign rating downgrades, a recession means that they now expect two rate cuts before the end of the year.
In the fourth quarter of 2016 GDP came in at -0.3% quarterly annualised growth followed by -0.7% in the first quarter of 2017, meaning that the country has now entered a technical recession. “This doesn’t mean much on its own, but since we’re already in a slow growth environment, with a weak start to the year, we, at Old Mutual Investment Group, will revise our own growth forecast substantially lower,” says Els. “From just above 1% expected for 2017, we will now likely only see around 0.7% growth in 2017.”
He points to the detail in the numbers announced today: “Agriculture was very strong at 22% annualised – based on the record summer crops – while mining was also positive at 12.8. But all the other sectors were negative, with notable examples being manufacturing at -3.7% and electricity, which surprised at -4.8%, owing to impact from drought and water reticulation.”
However, Els says that the largest falling sector was the trade sector at -5.9%, which was borne out by the household consumption spending rate that came in at -2.3%.
“What this essentially means is that the SARB is looking way behind the curve when it comes to rate cuts,” he warns. “We have inflation currently at 5.3%, but this is quickly heading towards about 4.8% in July. In addition to falling inflation, we have a stronger rand, an improving Current Account deficit, as well as a far reduced foreign financing need. Now the Reserve Bank is also faced with the reality of severe spending weakness. These factors all point to the need for the SARB to cut rates.
“The reason they haven’t started cutting rates so far comes down to the risks posed by the recent rating downgrades, politics and the rand, which are all make for an uncertain economic horizon,” adds Els.
“For now, weak consumer spending, within the concept of the current technical recession, provides the rationale for further rating cuts sooner rather than later in 2017.”
Els explains that following the Cabinet reshuffle by the President in April, his team revised their expectations for rate cuts to one cut in 2017 (from a previous expectation of two cuts in the second half of 2017 - a forecast in place since May last year) and two more in 2018. “We now believe that the two cuts in 2017 are back on the cards, and we expect a growing consensus among economists that calls for more rate cuts this year too,” he says.
“Should the SARB continue on their current path of holding interest rates, they will be making a serious policy error. Ultimately, we believe that that they will need to cut rates by July or September,” he concludes.