Despite Covid-19 the MPC should decrease the Repo rate further
JOHANNESBURG – Although many businesses, financial analysts, economists, the public and even in governmental circles feel the Monetary Policy Committee (MPC) of the SA Reserve Bank must lower the repo rate at its meeting to counteract the devastating effects of Covid-19, the MPC should do it solely on its “mandate”.
The MPC had set itself a target of 4.5 percent, the midpoint between 3 percent and 6 percent as a “default” rate to change the repo rate. The MPC by various occasions had stressed that the midpoint target is based on expected inflation and not on the current or historical level.
In this regard the inflation rate came in at 4.1 percent for March, just after their previous emergency meeting on April 14. It is expected that the inflation rate for April, which will be announced next week, stablished at 4 percent and, given the sharp decrease in fuel prices at the beginning of May, should decrease even further to 3.5 percent.
This should support the Reserve Bank’s inflation forecast of 3.6 percent for 2020 and 4.5 percent for 2021. Given this expected rates, the MPC should decrease the repo rate by at least 50 basis points although 100 basis points should be more applicable.
Another worrying aspect for the MPC is around the value of the Rand as a strong upside risk to the inflation forecast. At the previous meeting, South Africa was yet excluded from the Global Government Bond index (that was done on April 30) on the back that Moody’s also downgraded South Africa to junk in March.
It was for the MPC not clear what the effect of the exclusion will be on the Rand exchange rate and bond yields. It came clear after April 30 that this event was already discounted for during the middle of March. The opposite of expectations happened in both the Bond market and the foreign exchange market.
The R186 leading Government Bond already had decreased by more than 100 basis points to 7.4 percent and the rand exchange rate is now trading 80 cents lower than at the previous meeting on R17.96 a dollar.
It is now expected that the Rand should move as low as R16.80 a dollar by the end of the year. Given the lower risk for the currency and borrowing cost for government the MPC have ample room to lower the repo rate by at least 100 basis points.
If so it will mean that the repo rate was lowered by 3.25 percent this year alone, putting the rate on a record low 3.25 percent and more than half the 6.75 percent at the beginning of 2020. This will mean that Bank’s prime lending rate will decrease to 6.75 percent.
This will have a big effect on households businesses and debt. Small and enterprises will be able to apply for Covid-19 bridging financing (loans) much cheaper than three months ago. It may just be in time to safe many of these enterprises and prevent that hundreds of thousands workers lose their jobs.
Although many expect the Reserve Bank to be heavily involved with a stimulation of the economy to prevent a disaster of a devastating recession, poverty and unemployment, the MPC still have to be very cautious. Lowering the repo rate by too much too soon may put the Rand exchange rate under pressure and causes large capital outflows.
Both these effects will push the economy only into more difficulties. One would rather like to see the Reserve Bank using other instruments like quantitative easing to make more money available for Covid-19 financing for businesses.
Dr Chris Harmse is and economist and chief investment officer at Rebalance Fund Managers.