Our Hard Number Index of economic activity (HNI) was little changed in February 2014. As the chart below shows, the SA economy as indicated by the HNI is growing (numbers above 100 based on January 2010, indicate growth) but the pace of growth is slowing down slowed and that its forward momentum has stabilized at the slower pace first registered in January 2014 .
The HNI is compared to the Reserve Bank Coinciding Business Cycle Indicator that is based upon a larger set of data derived from sample surveys. As the chart shows, the Reserve Bank Indicator is only updated to November 2013. It also indicates a growing economy with the pace of growth picking up in November 2013.
The HNI is derived from two equally weighted and very up to date releases for SA unit vehicle sales and the notes issued by the Reserve Bank for February 2014. Both statistics reflect actual sales in February or real notes in circulation at February month end, making them hard numbers rather than estimates based on small sample surveys.
In February the unit vehicle sales on a seasonally adjusted basis declined from January levels while the note issue, adjusted for CPI, picked up some momentum, largely cancelling each other out,in the calculation of the HNI. While declining on a seasonally adjusted basis, unit vehicle sales, having peaked in early 2013, are still maintaining a satisfactory pace.
If the current trend in sales is maintained, the industry should be selling new vehicles at an annualised rate of 620 000 units in February 2015, that is about 6% down on the sales in February 2013, about 3% off current sales volumes and way ahead of the post recession sales volumes of early 2009. No doubt the industry would be well pleased should domestic vehicle sales decline by only 3% over the next year.
Interest rates and the availability of credit from the banks will influence these vehicle sales outcomes. The latest news on interest rates and the exchange value of the rand is rather encouraging in this regard. A recovery in the rand has helped reduce interest rates across the yield curve. A week ago, short term rates were expected to rise by over 2 percentage points over the next 12 months. Now they are expected to rise by only 1.66 percentage points over the same period.
Our view is that interest rates will not increase by more than 50bps over the next 12 months and even this increase is not at all certain. Rates may well remain on hold. The interest rate outcomes and the inflation outlook will depend mostly on what happens to the rand over the next few months. If the rand holds at current rates of exchange, the inflation outlook will improve and the case for raising rates at all will fall away. The expected state of the economy is for slower growth, as revealed by the business cycle and, in an up to date way, by the HNI, while it is also confirmed by credit growth and by growth in household spending: these are trending down rather than up. This strongly suggests that the interest rate cycle itself should be trending down rather than up. It would have done so but for the weak rand.
Joseph Stiglitz, a celebrated American economist, in his speech to the Discovery Investment Conference on Wednesday, 5 March, agreed with our long expressed view on the inadvisability of blindly targeting inflation irrespective of the state of the economy. We would add a further reason for not raising rates, namely the absence of any predictable influence of interest rates over the direction of the rand and therefore of inflation. As we have argued, using the evidence from the market, higher interest rates cannot be relied upon at all to add strength to the rand.
The value of the rand is determined by global forces well beyond the influence of SA short term interest rates. Yet by further reducing domestic demand and so the growth outlook and the case for investing in SA businesses, higher interest rates may well frighten away foreign capital and on balance weaken the rand.
Raising interest rates in SA is justified if domestic spending, fueled by domestic credit, is growing rapidly, thus helping to drive up the prices of goods and services. It is not at all justified if prices are rising because of reduced supplies of goods and services.
An exchange rate shock of the kind that has driven the rand weaker over the past six months, is as much a supply side shock as a drought would have reduced food supplies, so causing prices to rise. It makes no more sense to raise interest rates when a drought forces up food and other prices than when conditions in global capital markets drive down the value of the rand and similarly tends to push up prices.