Good case for interest rates being higher for longer

There is a good case for South Africa’s interest rates to stay higher for longer due to persistent inflation and the rise in government borrowing. 

This is feedback from Reserve Bank Deputy Governor Fundi Tshazibana, who told a Bank of America conference last week that inflation risks remain. 

In November, at its final monetary policy meeting of 2023, the central bank kept its main lending rate unchanged at 8.25%, its third pause in a row following ten consecutive hikes starting in November 2021.

“There still seems to be a good case for keeping rates higher for longer domestically,” Tshazibana said. 

This is because the government needs to raise borrowing while interest rates are higher and South Africa’s risk premium has risen. 

The National Treasury raised its borrowing to around R14 billion a week from August. 

“The underlying drivers of interest rates are going up. To maintain the value of the currency – that is, to stabilise inflation – actual rates must rise too,” she said.

Tshazibana also emphasised that the Reserve Bank is aware of the impact of raising interest rates and keeping them higher for longer on South Africans.

For interest rates to come down, she said there needed to be reforms to reduce the country’s risk premium and potentially a lower inflation target. 

“Higher for longer is not inevitable. We have to control inflation, but if we have different macro arrangements, that could be done more cheaply.”

This warning from Tshazibana stands in contrast to traders and investors, who expect the Reserve Bank to cut interest rates sooner than initially thought. 

Traders brought forward their bets for South Africa’s first interest rate cut to March 2024 after the amount of money flowing into the economy and loans to the private sector recorded their weakest growth in almost two years.  

Growth in money supply and private credit extension rose less than expected at 6% and 3.9% in October, respectively, from a year earlier.

Forward-rate agreements that speculate on borrowing costs show traders are now pricing in a 25-basis-point rate cut in March, which is sooner than most economists expect.

Before the data release, those bets were for a May rate cut.

Both indicators’ slowdown may signal strain in households and corporates’ finances from higher interest rates.

The Reserve Bank also warned in its Financial Stability Review that the quality of bank loan books has suffered amid high interest rates and announced plans to have lenders add protectively to their capital buffers in 2025.

“The longer interest rates remain high, combined with cost-of-living increases, the more borrowers will experience strain,” the Reserve Bank said. 

“This could manifest in rising non-performing loans and payment lapses, which could reduce capital and profitability in the financial sector,” it said.

The central bank said it has decided to implement a 1% counter-cyclical capital buffer for lenders commencing 1 January 2025, to be completed by the end of that year.

The buffer can be drawn down in the face of an economic shock, and countries who had them in place during the Covid-19 pandemic had found them to help relieve strain, it said.