US embassy cable - 05PRETORIA1506

UNCLAS SECTION 01 OF 02 PRETORIA 001506 
 
SIPDIS 
 
DEPT FOR AF/S/KGAITHER; AF/EPS; EB/IFD/OMA 
USDOC FOR 4510/ITA/MAC/AME/OA/DIEMOND 
TREASURY FOR OAISA/BARBER/WALKER/JEWELL 
USTR FOR COLEMAN 
LONDON FOR GURNEY; PARIS FOR NEARY 
 
E.O. 12958: N/A 
TAGS: ECON, EINV, EFIN, ETRD, BEXP, KTDB, PGOV, SF 
SUBJECT:  SOUTH AFRICA'S SURPRISE INTEREST RATE CUT 
 
 
 1. Summary.  On April 14, the South African Reserve Bank 
 (SARB) announced a 50 basis point reduction in its 
 repurchase rate (equivalent to the U.S. federal funds 
 rate) much to the surprise of South African economic 
 analysts.  SARB's justifications for reducing rates 
 include lower inflationary expectations, signs of weakness 
 in the manufacturing sector, and a benign inflationary 
 outlook over the next year.  The rand closed at 6.25, 
 compared to 6.13 rands per dollar just before the SARB 
 announcement, as the real interest rate differential 
 between the United States and South Africa slipped to 4.65 
 from 5.15 percentage points.  Tito Mboweni, SARB's 
 governor, reiterated the bank's goal of inflation 
 targeting rather than exchange rate or growth targeting. 
 Dropping interest rates now might signal SARB's growing 
 concern about sustaining South African growth in the midst 
 of a strong exchange rate.  End Summary. 
 
 SURPRISE INTEREST RATE CUT 
 -------------------------- 
 
 2.  The South African Reserve Bank's (SARB) Monetary 
 Policy Committee reduced interest rates by 50 basis points 
 bringing the repurchase rate down to 7 percent, the lowest 
 level since 2000.  Major banks followed with announcements 
 that they would also reduce their prime lending rates from 
 11 percent to 10.5 percent.  Real interest rates in South 
 Africa are now 4.40 percent (i.e., the repurchase rate 
 minus February's consumer price inflation of 2.6 percent). 
 The real interest rate differential between the United 
 States and South Africa narrowed to 4.65 compared to 5.15 
 percentage points before SARB's announcement.  The 
 reduction of the spread between real interest rates helps 
 explain the overnight depreciation of the rand via the 
 dollar. 
 
 Lower Inflation and Weakness in Manufacturing 
 --------------------------------------------- 
 
 3.  In explaining the interest rate cut, Mboweni noted 
 evidence of slower economic activity in the manufacturing 
 sector as a result of the move by the rand to a higher 
 trading range over the past six months.  In addition, he 
 cited recent evidence of slowing inflation and 
 inflationary expectations.  The latest inflation 
 expectations survey conducted by the Bureau for Economic 
 Research (BER) at the University of Stellenbosch showed a 
 significant decline in inflation expectations.  According 
 to the survey, CPIX inflation (consumer prices less 
 mortgages) expectations reached their lowest level since 
 the BER started the survey in 2000.  For the first time, 
 survey respondents expected inflation to fall below the 
 upper end of the 3-6 percent inflation target band.  On 
 average, CPIX inflation is expected to be at 4.5 per cent, 
 down from 5.5 per cent in the previous survey.  CPIX 
 inflation is also expected to remain within the target 
 range for the next 3 years. 
 
 Immediate Reaction 
 ------------------ 
 
 4.  The reduction in interest rates took most analysts by 
 surprise, as a Reuters poll of 15 economists done last 
 week predicted that the SARB would keep the repurchase 
 rate at 7.50 percent for the remainder of the year, with 
 any rise in 2006 limited to less than 50 basis points. 
 Standard Bank economist Monica Ambrosi asserted that key 
 inflation risk factors, such as the outlook for oil prices 
 and exchange rates, were more uncertain now compared to 
 February, when the majority of economists were expecting a 
 central bank interest rate reduction.  The Council of 
 South African Trade Unions (COSATU) called for additional 
 interest rate reductions to weaken the rand and welcomed 
 Mboweni's announcement. 
 
 SARB CONCERNS ABOUT SUSTAINABLE GROWTH 
 -------------------------------------- 
 
 5.  Comment.  The unexpected rate cut may signal that the 
 SARB is increasingly worried about the detrimental impact 
 of the strong rand on employment.  Significant job cuts 
 have been announced in the mining and textile industries, 
 citing high rand costs of production.  Recent deceleration 
 of growth in the manufacturing sector is also of 
 particular concern, as the manufacturing sector accounted 
 for 17 percent of real gross domestic product in 2004. 
 Manufacturing production growth sharply decelerated from 
 December 2004's 7.9 percent growth to 3.2 and 2.7 percent 
 in January and February 2005, respectively.  Despite dim 
 prospects for manufactured exports, production still 
 increased over the past year due to robust domestic 
 consumer demand.  Real domestic expenditures increased 6.3 
 percent in 2004.  End comment. 
 
 
FRAZER