Inside Insights 13 Sep 2010

Investment Intelligence|Inside Insights

A weekly, in-depth yet concise report on the most important recent market movements and economic developments.

Added on 13 September 2010 @ 11:13 AM

Support for a slowing recovery

Lower than expected domestic inflation - partly as a result of a strengthening rand - coupled with slowing global economic growth gave the Reserve Bank's Monetary Policy Committee (MPC) room to reduce the repo rate to 6%, with the prime rate falling to 9.5%, the lowest rate in 30 years. While the rate cut gives more-or-less immediate relief to existing borrowers, it is unlikely to give the economy a boost in the short-term as the demand for credit from businesses and households remains depressed, and banks' lending criteria remain tight. As we've said often before, it usually takes 12-18 months for changes in interest rates (up or down) to be fully felt. This is why central banks are always forward-looking in their monetary policy operations. In this light, the Bank's governor, Gill Marcus noted that the scope for further cuts was ‘limited'.

Interestingly, the rand appreciated shortly after the announcement, contrary to the carry trade argument which would imply depreciation due to the reduction in the interest rate differential between South Africa and the developed world. On the other hand, this difference between local and developed world interest rates remains substantial despite the latest cut. The rand, which had appreciated by 4.6% against the dollar in July, gained more ground on Friday to close at R7.17/$ from R7.23/$ (on Wednesday) and at R11.05/£, the strongest level since June. Amid rand appreciation and continued foreign demand (net R5.8bn last week alone), the yields on South African bonds declined further.

Positive US economic data lifted investor sentiment for a second consecutive week, which is another potential reason behind the rand's rise. The US trade deficit narrowed more than expected in July, with imports falling and exports improving. Initial unemployment claims declined by 27,000 in contrast to most economists forecast of an increase of 20,000. Further boosting sentiment, the European Central Bank Governing Council commented that the eurozone was on the brink of a sustainable recovery. This has aided in reducing concerns over the staggering global economic recovery. The FTSE 100 and Asian markets reached 4-month highs, and the S&P 500 climbed to a one-month high above 1110. However, renewed fears over the health of the European banks capped further gains. Due to the persistent uncertainty in the global economy, gold climbed to a two-month high above $1262/oz. However, gold lost some gains to profit-taking and the better-than-expected US data, declining on Thursday by the largest percentage loss in six weeks.

Manufacturing growth slows

Manufacturing data released by StatsSA on Wednesday supported the rate cut decision. Though production in South Africa's second largest sector grew by more than expected in July, a slower pace of expansion is clearly evident. Production grew by 7.5% year-on-year in July, down from June's revised 9.3% growth rate, supported mostly by the export-orientated industries, including petroleum and chemicals, the motor industry (currently crippled by strike action) and the wood, paper and publishing sector. The domestic-orientated (and import-competing) food and beverage and clothing and textile sectors contracted on a year-on-year basis in July. Overall though, most manufacturing sub-categories expanded.

The manufacturing sector is expected to feel the pinch as global growth slows in the coming months, not to mention the impact of the strong rand. Domestic demand for manufactured products is unlikely to pick up the slack, because business investment spending remains depressed, even though consumer spending is recovering. The purchasing managers' index (PMI) also points to slower growth, coming in at only 50.3 in August. So growth rates are expected to taper off, even as the volume of production remains well below the 2008 peak (see graph).

Mining production fell by 1% year-on-year in July, according to StatsSA data, also released last week. This is down from June's revised 0.4% rise. A 3.4% decline in gold production, despite the fact that the dollar gold price is at record high levels, is one of the main reasons for the fall in overall mining output levels. Mining production slumped by 8.2% year-on-year in May, and in volume terms also remains far below levels achieved before the recession.

The Week Ahead

• The FNB/BER Consumer confidence index (CCI) for third quarter will be released on Monday. It is expected to show a mild decline in confidence levels among SA households, due to the slowing economic recovery.

• StatsSA releases data on the number of building plans passed in July, a key indicator of future activity in the struggling construction sector. Unfortunately, the numbers are expected to show further declines in the residential and non-residential sectors.

• Global data releases of note this week: Eurozone industrial production and inflation numbers; UK August inflation numbers; key US retail sales data for August and Q2 consumer confidence data, as well as August inflation and industrial production and Q2 current account balance; Japan industrial production data for August; Chinese inflation and fixed investment numbers.

Fairbairn Capital | Old Mutual

Investment Intelligence|Inside Insights