In the past week, we have asked ourselves this question: what are the chances that the SARB could cut interest rates by 100bps as opposed to the usual 50bps at the MPC meeting in February? In an attempt to answer this question, it has become very clear to us that the South African economic downturn has worsened.

Incoming economic data continue to show that the economy is taking strain, and the global economic downturn aggravates this situation. There are increasing numbers of retrenchments in most sectors including mining, retail, manufacturing and financial services. Depressed consumer and business confidence levels suggest further weakness in the domestic economic activity this year. Export growth is likely to remain lackluster through 2009 on weak global demand. Domestic demand would also remain constrained by tight monetary conditions. Indeed, at these levels, monetary policy has become highly restrictive and, to a certain degree, harmful to the local economy.

The figure below shows that financial markets? inflation expectations are well anchored. Going forwards, we expect readings from other economic agents, specifically labour unions and business leaders, to also indicate a moderation in inflation expectations as the uncertainty regarding the potential path SA inflation could take would be significantly reduced when Stats SA provides full details of the long-awaited new CPI inflation outcome in February.

Going into the February MPC meeting, we expect the SARB to cut interest rates by 100bps as opposed to the usual 50bps in recognition of the weakening domestic economy and improved medium-term inflation outlook (we have previously believed that the SARB would cut interest rates by 50bps).

The SARB has yesterday announced that the MPC meeting which was originally scheduled for the 11 and 12 February 2009, has now been moved a week earlier to 4 and 5 February 2009. The Bank said that the change was necessitated by the fact that the Budget Speech by the Minister of Finance will be presented in Parliament on the 11 February 2009.

The bond market has rallied on the announcement of the new MPC date (R157 government bond yield closed down 1.0% yesterday from its previous close). The FRA curve, even before the announcement, has fully priced in a 100bps interest rate outcome at the February MPC.

Our take: We believe the SARB is likely to cut interest rates by 100bps on the 5th February 2009. To shift the MPC meeting date a week forward only reinforces our expectations. We would be surprised if the Committee members decide to reduce interest rates by only 50bps.

Source: Investec Private Bank