Warning about interest rates in South Africa

Higher administered prices for utilities like electricity and a more challenging global backdrop present significant upside risks to South Africa’s inflation outlook.

These factors could significantly impact South Africa’s interest rates and convince the South African Reserve Bank (SARB) to keep rates higher for longer.

The Monetary Policy Committee (MPC) is set to meet again this week, with many experts expecting the committee to announce another 25 basis point interest rate cut on Thursday, 30 January.

This would be the third cut in the current cutting cycle, with the SARB having implemented two 25 basis points cuts at its past two meetings.

This came after a severe hiking cycle that started in November 2021 and saw interest rates raised by a cumulative 475 basis points.

FNB economists said in the bank’s latest Economics Weekly that the MPC faces a balance of inflation risks on the upside and downside.

At the last MPC meeting in November last year, the committee considered both of these upside and downside inflation risk scenarios. 

Upside risks included higher administered prices like electricity inflation and a more challenging global backdrop.

Since 2007, electricity prices in South Africa have risen far above inflation by 927%. 

This trend is set to continue this year, with Eskom having requested a 36% price increase to cover the rising cost of producing electricity.

Eskom requested total revenues of R446 billion for the 2026 financial year, R495 billion for 2027, and R537 billion for 2028.

The proposed average price hikes for Eskom’s direct customers are 36.15% from 1 April 2025 to 31 March 2026.

For the subsequent years, the utility is seeking increases of 11.81% from 1 April 2026 to 31 March 2027 and 9.10% from 1 April 2027 to 31 March 2028.

“Higher electricity inflation is expected to propel inflation higher from the second half of 2025,” FNB said. 

The second upside risk, a challenging global backdrop, could include trade tariffs, higher inflation in certain regions, a stronger dollar, and tighter policy from the US Federal Reserve. 

FNB economists explained that the past few years have been tumultuous as geopolitical tensions have taken centre stage.

Many have been concerned over the higher likelihood of conflicts, disputes, and tensions between countries.

However, FNB said these fears have since largely subsided and have been replaced with mounting trade tensions.

“Unfortunately, less cooperative global trade and defence policies may raise supply-chain disruptions and fiscal consumption spending, with the result being reflationary pressure,” they said. 

FNB said this poses a risk of tighter monetary policy in South Africa.

“However, prevailing fundamentals suggest that restrictive monetary policy has managed to contain inflation and that a continued interest rate cutting cycle in various parts of the globe is still supported, including in South Africa,” they said.

Therefore, downside risks to the local inflation outlook include de-escalated geopolitical risk and lower oil prices, which FNB said are now more firmly in view. 

According to the MPC’s last statement, inflation was slowing primarily due to a stronger exchange rate and lower oil prices, which supported the deceleration in goods inflation. 

Overall, FNB said inflation is expected to remain contained over the medium term. 

“This is expected to support a continued slowing in backwards-looking inflation expectations, and we have subsequently seen this come through in the fourth quarter 2024 BER inflation expectations survey results, which were broadly anchored at the SARB’s preferred target,” they said. 

The MPC forecasts economic growth to rise from 1.1% in 2024 to 2.0% in 2027.

Inflation is expected to oscillate around 4.5% over the forecast horizon, falling to 4.0% in 2025. 

“Inflation data points since the last MPC meeting have continued to surprise analysts to the downside,” FNB said. 

“Headline inflation has remained at the bottom of the inflation target band, supported by positive base effects and demand-driven pressures remaining contained.” 

“This trend is expected to remain intact until the second half of 2025 when these drivers should become less favourable.” 

Therefore, the economists explained that while current readings of data suggest that there is ample space to cut interest rates, a forward-looking approach still dictates that Taylor rule projections will dampen the amount of interest rate cuts.

The Taylor Rule is a guideline for central banks to determine the appropriate level of short-term interest rates based on economic conditions, specifically inflation and economic output.

“Nevertheless, the MPC’s expectation that inflation will remain around 4.5% over the forecast horizon, should they remain intact, still supports a continued cutting cycle,” FNB said. 

“In line with this, we see another 75 basis points worth of cuts delivered cumulatively over the first three meetings in the first half of 2025, starting with 25 basis points at January’s meeting.”

“On balance, the MPC should consider the impact of the unfolding of both these scenarios and the cutting cycle should be uninterrupted.”