The credit and money supply numbers for April 2011 indicate that the pace of money supply and credit growth, especially growth in mortgages, pedestrian before, is slowing down gradually, rather than accelerating. The growth trends in M3, the broadest definition of the money supply including almost all deposits issued by the banks, is most clearly pointing lower.
It is demands for bank credit that lead the money supply process in SA. As the banks lend more, the Reserve Bank accommodates the banks with additional cash- that is cash reserves – at the prevailing repo rate. More credit demanded leading to more money supplied is the modus operandi of the SA Reserve Bank. The demands for credit lead the supply of cash and more broadly defined money. A large proportion of SA bank lending is on mortgage and mortgage demands remain especially tepid as we also show below.
Growth in mortgage lending follows house price inflation, as we show below, where it may be seen that the price of the average home is now unchanged compared with a year ago. A housing boom leads to a credit boom and rapid growth in the money supply as it did between 2003 and 2008 – and when the housing boom slows down, so does money supply growth as it has recently. Interest rate settings have proved incapable of effectively moderating the credit and money supply cycles in SA.
Until the housing market picks up the growth in bank lending will remain subdued. The recovery in the housing market has lagged behind the recovery in the economy. It will take further growth in formal sector employment to revive the housing market.
Lower interest rates on mortgage loans, applied much earlier in the slow down, might have helped moderate the contraction in the credit and money cycles, but these now appear most unlikely given the recent uptick in inflation. The credit and money supply numbers should however help dissuade the Reserve Bank from raising interest rates.
There is clearly no money or credit supply growth reason for raising interest rates, nor any excess demands for houses or anything else that would need to be restrained by higher interest rates. Indeed the opposite, lower rates, would still appear appropriate, given the state of the economy and in particular the state of the housing market and the construction industry that is an important employer of labour.
We show below the recent collapse in the cycle of buildings completed. We show how building plans passed have led the building industry lower. The indication is that he planning cycle has at best bottomed out, offering only the hope that construction activity will soon also bottom out and recover.
It is of interest to note that house prices lead not only mortgage demands but also building plans passed. It takes higher house prices to encourage construction activity.
The weak state of the credit and housing markets, that are inextricably bound together, makes the case for lower rather than higher interest rates. The Reserve Bank appears understandably reluctant to raise interest rates in the circumstances. The currently higher inflation rate is of the supply side, cost push administered price variety over which monetary policy has no influence and if it persists will weaken demand further.
Furthermore, as we have mentioned before, we have found no evidence of second round effects of inflation, that is, more inflation that leads to more inflation expected that leads in turn to more actual inflation. Fighting these feared second round effects have become an argument for higher interest rates, regardless of their negative effect on economic activity. Such arguments should be ignored and the SA public and market place made to understand why.
To view the graphs and tables referred to in the article, see Daily Ideas in todays Daily View: Daily View 1 June: Credit and housing markets: Still no case for higher rates