Reserve Bank may need to keep interest rates higher for longer

South Africa could benefit from keeping interest rates higher for longer, as this would help lower the risk associated with local assets through higher potential growth.

This is according to FNB economists Mamello Matikinca-Ngwenya, Siphamandla Mkhwanazi, Thanda Sithole, and Koketso Mano.

They said that after recording an average of 8.7% in 2022, global inflation fell to 6.8% in 2023 and is expected to fall further to 5.9% this year. 

By 2026, it should settle slightly below the historical average of 3.8%.

They explained that this trend is driven by declining inflation in advanced economies. It is expected to fall from 4.6% in 2023 to 2.6% in 2024, reaching the conventional 2% target by 2025. 

However, this will differ for emerging markets, where inflation is expected to remain at 8.3% in 2024 and slow to 6.2% in 2026. 

Emerging markets tend to have higher targets than advanced economies. However, the protracted reversion of inflation towards pre-pandemic levels, in many cases, highlights the vulnerability to price shocks. 

This vulnerability is further amplified by fiscal pressures and potentially higher neutral interest rates, which would suggest that interest rates need to be higher than initially thought to bring inflation down. 

However, some central banks in emerging markets are cutting interest rates – but not South Africa.

The South African Reserve Bank (SARB) started its hiking cycle in November 2021 to bring inflation down and within the target band of 3% to 6%.

Since then, the central bank has raised interest rates by a cumulative 475 basis points, bringing the repo rate to a 15-year high of 8.25% and the prime lending rate to 11.75%.

While this has seen inflation fall, the Reserve Bank has made it clear that it will only consider cutting interest rates when inflation is anchored around the mid-point of the target range, 4.5%.

This is only projected to happen in the second half of this year or even next year.

In contrast, emerging markets in Asia have generally experienced a milder peak in inflation relative to other emerging markets. 

This primarily reflected a less disruptive shift from lockdowns and a slower lift in activity to pre-pandemic levels, which allowed for better management of supply-demand imbalances. 

In addition, the region experienced more stable currencies, which assisted in softening the exchange rate passthrough. 

FNB South Africa chief economist Mamello Matikinca-Ngwenya

Eastern Europe had the opposite experience. Russia’s invasion of Ukraine had widespread implications for currencies as well as food and energy prices, leading to double-digit interest rates in some countries. 

Those that have started a cutting cycle have reduced rates gradually, bar Moldova.

Latin America has also experienced currency weakness, and accommodative policy supported activity normalisation. 

“What is interesting about this region is that monetary policy adjusted quickly, with countries like Brazil starting to lift rates in early 2021,” the economists highlighted. 

To counter accommodative fiscal policy and rising inflation, Brazil raised its nominal policy rate from 2% in March 2021 to 13.75% by August 2022. 

This helped guide inflation from a peak of 12.1% to a low of 3.2% in mid-2023.

Currently, Brazil’s inflation is around 4.5%, which is in line with the upper end of their inflation target tolerance band. 

With inflation projected to fall to the 3% target, inflation expectations anchored, and fiscal consolidation expected in the forecast period, the central bank started cutting rates in August 2023, and they now stand at 10.5%. 

Similarly, Chile started cutting rates in July 2023, with inflation falling from a peak of 14.1% to around 4% currently. 

Columbia’s cutting cycle began end-2023 but has been more gradual, and rates are still elevated at 11.75%. While the central bank expects inflation to slow to the 3% target by 1H25, it is currently over 7%.

South Africa, therefore, started hiking interest rates later than most of these countries, and while a lower inflation peak assisted in containing the interest rate level, inflation has proven stickier as services inflation normalises.

As it stands, the SARB predicts that inflation will only settle at target in 2026, with a higher probability of exceeding expectations. 

Furthermore, a volatile currency and loose fiscal policy have only compounded neutral interest rate pressures.

“If we assume that South Africa and countries such as Brazil, Mexico and Colombia keep rates at current levels and inflation falls to target within a year, all else being equal, the real interest rate earned from investing in the Latin American countries would be more competitive,” the economists said.

“In addition, even though these countries have started cutting rates, estimates are that policy is more restrictive than in South Africa, thereby driving inflation more forcefully towards the target.”

“All these factors suggest that South Africa may need to keep interest rates high for longer, taking advantage of falling inflation to raise real policy rates.” 

In addition, they said efforts to lower neutral interest rates are crucial. In other words, it is important to reduce the risks associated with local assets through higher potential growth and, potentially, a lower inflation target.


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