Finance

Clear path for South African interest rate cuts

The path to interest rate cuts has become considerably clearer over recent months, with South African interest rates expected to be cut later this year.

The South African Reserve Bank (SARB) started hiking interest rates in November 2021 and has increased rates by 475 basis points.

This has brought the repo rate to a 15-year high of 8.25% and the prime lending rate to 11.25%.

Its efforts to bring inflation down and within its target range of 3% to 6% have borne some fruit, with the latest inflation print in May coming in at 5.2%.

However, this is still not low enough for the Reserve Bank to start cutting interest rates. It wants to see inflation come down sustainably and be anchored around the midpoint of this range, 4.5%.

Asset manager Futuregrowth said political uncertainty still lingers domestically and abroad, with more than 2 billion people eligible to vote in national elections worldwide in 2024.

However, it said the path for interest rates became clearer in the past quarter.

The Swiss National Bank led the charge on the interest rate-cutting cycle in the developed world, cutting its main policy rate by a cumulative 50 basis points in recent months.

The Bank of Canada, Sweden’s Riksbank, and the European Central Bank (ECB) followed suit, commencing their respective interest rate cutting cycles in the past quarter.

“However, with lingering uncertainty on the sustainability of the recent cooling in inflation, Christine Lagarde and her Governing Council colleagues have clearly cautioned the market against expectations of sequential interest rate cuts,” Futuregrowth said.

“Monetary policy calibration will remain highly data-dependent, with a further cooling of inflation expectations necessary to drive a faster and deeper interest rate cutting cycle.”

In addition, it said the US Federal Reserve Bank will rightfully remain a laggard in this interest rate cycle, given the relative stickiness of US headline consumer prices and the still robust labour market. 

The Fed faces a wider inflation gap, with year-on-year consumer price inflation stuck well above its 2% target level. 

However, inflation expectations remain reasonably contained, which allows for policy cuts once the Federal Open Market Committee is comfortable with the sustainability of the disinflation trend. 

Outsized household savings have coincided with the stickiness in consumer prices in recent years. However, indications that these savings have now been depleted lay the grounds for moderating consumer spending and an eventual slow and shallow interest rate cutting cycle.

Futuregrowth said domestic headline CPI flatlined at 5.2% year on year in May. 

“While consumer inflation remains elevated and sticky, recent months have provided downside inflation surprises relative to median market expectations,” it said. 

“These downside surprises have been aided by colling energy prices and muted food price pressures, against our expectations of upside risk stemming primarily from the El Niño weather pattern and consequent drop in domestic white maize harvests.” 

“Furthermore, contained global food inflation, when lagged by 7 to 9 months, is highly correlated to domestic food inflation and will continue to stem domestic price pressures in the medium term.”

Futuregrowth predicts that the nominal repo rate has peaked at 8.25% in the current interest rate cycle. 

Despite the already elevated real rate environment, the SARB will rightfully remain hawkish until convinced that domestic consumer price inflation has moved sustainably towards the 4.5% year-on-year midpoint of the inflation target band. 

“We expect this comfort to be reached in the third or fourth quarter of 2024, allowing a shallow and gradual interest rate cutting cycle to follow,” it said.

The SARB’s Monetary Policy Committee is set to make its next decision on interest rates on 18 July.

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