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Unchanged repo rate the right decision

Economy still sluggish and workers struggling to keep up with high fuel and electricity prices

The South African Reserve Bank’s Monetary Policy Committee took the correct decision by not increasing the repo rate today (10 November 2011).

The economy is still sluggish and workers are struggling to keep up with high fuel and electricity prices.

Econometric analysis by UNISA’s Bureau of Market Research, as commissioned by UASA, to determine the optimal prime interest rate for South Africa taking account of both inflation and unemployment and not only inflation, also shows that the repo rate should not increase further.

Two types of analyses were performed, namely:

  • Option 1: Determining the optimal prime interest rate considering the official unemployment rate and consumer price inflation rate; and
  • Option 2: Determining the optimal prime interest rate considering the expanded unemployment rate and consumer price inflation rate.

The results show the optimal prime interest rate to be:

  • Option (1) 9%; and
  • Option (2) 6,05%.

Pressure for interest rates to increase is mounting due to the consumer price inflation rate increasing and the unemployment rate decreasing. The average consumer price inflation rate increased from 4,6% in Q2 2011 to 5,4% in Q3 2011, whilst the official and expanded unemployment rates declined to 25% (from 25,7% in Q2 2011) and 36% (from 36,9% in Q2 2011) respectively.

However, the prime interest rate has been on elevated levels (compared to the optimal rate) for longer than two years thereby preventing the economy from a faster recovery and unemployment to decrease at a quicker rate.

In addition, the National Credit Act is also rationing the uptake of credit thereby assisting the repo rate in curbing the rate at which new credit is extended to the private sector. Consequently, the role of the repo rate in stemming the rate of credit extension should be viewed in conjunction with the role played by the National Credit Act.

The analysis also showed that interest rates in South Africa are not very effective in stemming the rate at which consumer prices are increasing - as it first has to increase unemployment before the pace of price increases slows. This is due to the many structural problems in the economy preventing interest rates to become a very effective inflation curbing tool.