A further reduction of at least one percentage point is possible
If the South African Reserve Bank were concerned about both inflation and unemployment, serious consideration would have been given to reducing the prime interest rate by one percentage point instead of leaving the repo rate unchanged at 5,5%, as was announced earlier today.
The latest UASA Prime Interest Rate Barometer, which measures what the prime interest rate should be by taking both inflation and unemployment into account, edged up to 7,9% in the third quarter of 2011 compared to 7,2% in the second quarter of 2011.
However, this is still more than one percentage point lower than the current prime interest rate of 9%. And if the official unemployment rate of 25,7% is replaced with the expanded unemployment rate of 33,9% in the above equation, the prime interest rate should only be 6%.
A further reduction of at least one percentage point is thus possible without adding huge increasing pressure on the consumer price index, given banks' reluctance to grant credit in current depressing economic circumstances.
The proposed reduction in the repo rate is necessary to relieve the shackles on the South African economy. Given that most parts of the world is re-entering a phase of either low economic growth, or even a contraction, lower interest rates will be necessary to relieve the pressure on the South African economy. In addition, it should contribute to averting a new round of large job losses. Also, it will make it a bit easier for struggling households to breathe.
Although the consumer price inflation rate is on an increasing trend with CPI for August registering a rate of increase of 5,3% (the same as in July); and will most probably experience further pressure to increase from e.g. the weaker exchange rate, there will also be price relieving pressures in the form of lower commodity prices as a result of weakening demand growth in the rest of the world.
Against the above background, UASA is of the opinion that the balance of pressures is still toward a reduction in the repo rate of at least one percentage point.
The UASA Prime Interest Rate Barometer is based on the Rudebusch Equation developed by Dr Glenn Rudebusch, senior vice-president of the Federal Reserve Bank of San Francisco in the United States of America. Research is undertaken on behalf of UASA by the Bureau of Market Research (BMR) at the University of South Africa.