Interest rates slashed by 100 basis points due to declining inflation and a rapidly slowing economy

CPIX inflation slowed down to 10,3% year-on-year in December last year, after peaking at 13,6% in August. Despite a weaker and more volatile rand exchange since late last year, inflation is expected to be significantly lower by mid-2009, largely on the back of base effects and methodological changes to the consumer price inflation basket as from January this year.

Global economic conditions are deteriorating further, with a number of the major economies already in recession. The South African economy has slowed down significantly up to late last year, with some prominent sectors such as mining, manufacturing and wholesale and retail trade contracting sharply. In some sectors, including the abovementioned, there have also been some job losses in 2008.

In view of current and expected economic conditions, especially taking into account declining inflation, interest rates are forecast to be cut further during the course of the year. Currently the expectation is for prime and mortgage rates to reach a level of 11,5% by year-end. Despite expected lower inflation and interest rates, the economic conditions, impacting adversely on employment and household income, are set to keep the household sector under some financial pressure up to the second half of the year.

On the residential property market front, the affordability of housing came under much pressure as a result of a number of interest rate hikes between mid-2006 and mid-2008, declining growth in real household disposable income, the National Credit Act and the tightening of banks’ credit criteria. Although interest rates were cut by 150 basis since December last year, causing mortgage repayments to drop by 8,1%, they are still 24,6% higher than in June 2006 when the mortgage rate was at a level of 10,5%.

Against this background, the housing market continued to slow down in recent times, with prices declining marginally in nominal terms in January this year, while in real terms, prices were down by 8,6% y/y in December 2008.

The residential property market is forecast to bottom around mid-2009 and to gradually recover in the second half of the year on the back of lower inflation and interest rates and somewhat better economic conditions. However, levels of activity in the housing market are expected to remain relatively subdued in the first half of the year, while house prices are projected to drop by 2,5% in nominal terms and by 8% in real terms. The housing market is expected to only show a noticeable improvement in 2010 and beyond.

Courtesy Jacques du Toit Senior Economist ABSA Bank

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