Interest rate relief on the cards for South Africa

Interest rates in South Africa are set to be cut sooner than expected as inflation steadily falls below the Reserve Bank’s target, fuel prices fall, and positivity surrounding the Government of National Unity (GNU) boosts the rand. 

At the end of last month, the Reserve Bank’s Monetary Policy Committee (MPC) voted to leave the repo rate unchanged at 8.25%, with the prime lending rate at 11.75%.

The bank has raised interest rates by 475 basis points over the past few years to combat rising inflation and support the local currency. 

However, Standard Bank’s head of macroeconomic research, Dr Elna Moolman, said this hiking cycle has ended, with rates remaining unchanged for the past six Monetary Policy Committee (MPC) meetings. 

Uncertainty remains about when the Reserve Bank will cut interest rates, and volatility and uncertainty in the aftermath of South Africa’s election may delay relief. 

Moolman explained that financial market volatility and uncertainty are temporary and should not be a factor when the MPC meets again at the end of July. 

By then, the country’s political situation should have stabilised, and greater certainty around government policy will give financial markets a relative sense of calm. 

This will make hard economic data the focus of attention for the MPC, with the country’s steadily declining inflation and lacklustre growth taking centre stage.

“If we are right that consumer inflation should continue to drift sideways and be around the midpoint of the target range towards the fourth quarter of this year, then this should provide scope for the Reserve Bank to cut interest rates,” Moolman said.

Inflation should continue to decline as two major drivers of inflation have largely been nullified in recent months – load-shedding and high petrol prices. 

Load-shedding exacerbated the inefficiency of South Africa’s economy and generally raised the cost of doing business as companies had to spend billions on backup power sources. 

A significant petrol price cut in June is likely to be followed up by another cut in July, which will bring the price of fuel down by around 10% over the two months. 

However, Moolman cautioned that the cutting cycle will likely be shallow and short until inflation is comfortably below or at the Reserve Bank’s 4.5% mid-point of the target range. 

She also said Standard Bank only expects the cutting cycle to begin in September and will consist of just four 25 basis points cuts. 

This would bring the repo rate down to 7.25% and the prime lending rate to 10.75% – a small but not insignificant relief for consumers. 

Overall, Standard Bank expects the repo rate to remain above 7% for the next two years as they believe inflation will remain sticky and structurally higher than in the past. 

This is largely due to expectations that the price of oil will remain high to supply shocks and big producers maintaining or even deepening their cuts to output to keep prices elevated. 

Another factor is that inflation is sticky in the world’s largest economies, including the US, the UK, and the European Union. 

This means their central banks are unlikely to significantly cut rates, making the Reserve Bank hesitant to sharply reduce the repo rate out of fear that it would weaken the rand compared to major currencies. 

Also, elevated inflation in other parts of the world may lead to South Africa ‘importing’ inflation through the rising cost of goods and services procured from countries with rising prices. 

In recent weeks, investors and traders have increased their bets that South Africa’s interest rates will come down more sharply and sooner than Moolman predicts. 

On the back of positive news surrounding the formation of a GNU, financial markets are betting on earlier and sharper rate cuts as the rand is expected to strengthen. 

If the local currency strengthens significantly, it will have a major impact on inflation, as South Africa imports a significant amount of goods, particularly fuel. 

A stronger rand will make importing these goods cheaper and thus reduce inflation. 

Old Mutual Wealth investment strategist Izak Odendaal said that because of this, interest rates might even be cut at the MPC’s next meeting in July. 

While the decision at the last meeting in May was unanimous in favour of keeping rates unchanged, there was a significant shift in the outlook of the MPC. 

Oil price and exchange rate risks have abated somewhat, and the Reserve Bank now forecasts that inflation will reach its 4.5% objective in the second quarter of next year, earlier than previously stated. 

The Bank remains concerned about elevated surveyed inflation expectations, which tend to lag actual inflation. In other words, as inflation falls, expectations will probably be pulled lower. 

Inflation risks are now viewed as being “balanced” rather than “biased upwards” – a key shift in sentiment from the MPC, Odendaal said. 

Barring a serious market dislocation, Odendaal said the MPC will likely start a modest cutting cycle in the coming months, perhaps as early as the next meeting in July.