One more Reserve Bank interest rate hike – then a pause

Nedbank said the South African Reserve Bank (SARB) is set to implement what will likely be the final hike in this cycle at the Monetary Policy Committee (MPC) meeting in July.

The SARB has been in a hiking cycle since November and has implemented a consecutive 475 basis points of hikes, bringing the repo rate to a high of 8.25%.

These hikes were implemented in an attempt to bring South Africa’s high, sticky inflation down and within the SARB’s target range of 3% to 6%.

Over the past few months, inflation outcomes have been more encouraging, which suggests inflation is finally shifting down a gear.

Headline inflation fell by more than market expectations to a one-year low of 6.3% in May after slightly easing to 6.8% in April from 7.1% in March.

Although food inflation remained high, it slowed noticeably to 12% from a peak of just over 14% in March.

However, underlying price pressures proved stickier, with core inflation only dropping slightly lower to 5.2% from 5.3%.

Nedbank expects the downward trend in headline inflation to intensify during the second half of the year.

Strong base effects, lower global food, oil, and other commodity prices combined with much weaker domestic demand will likely offset the impact of a volatile rand and persistent load-shedding. 

“We now see inflation ending the year at 5%, lower than our previous forecast of 5.2%. Overall, headline inflation is forecast to average a lower 5.9% in 2023 (6.1% previously), before receding to 4.8% and 4.6% in 2024 and 2025, respectively,” it said.

Nedbank said most of the upside risks to the inflation outlook identified at the May MPC meeting have also eased. 

“On the domestic front, electricity supply proved fractionally more reliable than most expected this winter, and the rand pulled back from record lows against a weaker US dollar,” it said.

However, despite these hopeful developments, a vulnerable rand and the likely return of more severe load-shedding remain the key upside risks to the inflation outlook.

Nedbank, therefore, forecasts one last rate hike of 25 basis points in this cycle for next week’s meeting. 

“Although we still believe that the SARB has done enough to tame inflation and facilitate a sustainable decline towards the target range, we suspect that the MPC will err on the side of caution.”

“In our opinion, the recent rise in inflation expectations, the threat of renewed severe load-shedding, and the rand’s extreme vulnerability against the backdrop of the Fed’s hawkish rhetoric will set the tone for next week’s decision.” 

Nedbank said it is also possible that the SARB would argue that the damage of pausing too soon is greater than the cost of over-tightening. 

“Too restrictive policy can easily be reversed while structurally higher inflation and persistently rising inflation expectations will require even greater economic sacrifices to rectify.”

However, another 25 basis point hike will make South Africa’s monetary policy highly restrictive. 

“Based on our inflation forecast, which is not far off SARB’s estimates, the real repo rate will jump to over 3% in July, climbing to around 3.5% by year-end, well above the SARB’s real neutral rate of around 2.5%.” 

“Given that the aggressive tightening over the past two years is already visible in slowing credit demand, rising loan defaults, and stagnant consumer demand, we don’t see the need for further rate hikes this year.” 

Nedbank expects the easing cycle to start early next year.