Reserve Bank expected to keep interest rates higher for longer

The South African Reserve Bank will begin cutting interest rates in the coming months. However, this cutting cycle will be short and shallow, ending at a terminal repo rate of 7.5% and a prime lending rate of 11%.

This is feedback from an economist at Coronation, Marie Antelme, who said the Reserve Bank’s ability to cut interest rates is limited by the government’s weak financial position and a potential lowering of its inflation target. 

The Reserve Bank has been extremely cautious about the outlook for inflation in South Africa, with food inflation remaining particularly sticky. 

It will be worried that a premature rate cut or too deep of a cut will weaken the rand and potentially reignite inflation. 

If the Reserve Bank cuts rates before the US Federal Reserve, money will flow out of South African assets towards markets with a better risk-adjusted return. 

However, the Federal Reserve has signalled that it is close to cutting interest rates, with its cutting cycle likely to begin in September. 

Weaker-than-expected economic data in the US has brought forward potential rate cuts, and with financial markets experiencing a meltdown on Monday, cuts may begin even sooner. 

This will give the Reserve Bank more room to cut interest rates at its next meeting in September, with Antelme saying it is likely to begin its cutting cycle then. 

However, she only expects a 75 basis points cutting cycle, which would provide little relief for South African households and consumers. 

The Reserve Bank has hiked its repo rate by 475 basis points since November 2021, meaning a 75 basis point cutting cycle is unlikely to have a major impact on the cost of borrowing. 

Such a short and shallow cutting cycle would bring the repo rate to 7.5% and the prime lending rate to 11%. 

Antelme said the cutting cycle will be limited by the government’s weak fiscal position and the potential lowering of the inflation target in 2025 towards 3%. 

Antelme is not the only economist to forecast a short and shallow cutting cycle. Stanlib chief economist Kevin Lings also said that inflation and interest rates will likely remain higher for longer. 

Lings explained that several forces are still driving inflation higher, making it difficult for the Reserve Bank to cut interest rates significantly. 

Inflation has been largely driven by the increasing prices of government-regulated services, with private sector contributions being comparatively smaller.

For example, electricity prices have seen an average annual growth of 15.2% in the first five months of 2024, consistently remaining above 6% for many years.

Similarly, water costs have risen by an average of 7.9%, education expenses by 6.1%, and medical aid costs by 10.6% during the same period.

These consistent price hikes contribute to sustained high inflation since they affect nearly all areas of economic activity, raising business costs and, in turn, prices.

Lings noted that bringing the inflation rate down to 4.5% or lower depends significantly on controlling the cost increases of these essential services.

Unfortunately, the extensive infrastructure backlogs the country is facing, coupled with the public sector’s severe fiscal constraints, suggests that administered prices are likely to escalate for many years.

Another factor driving inflation higher in South Africa is the consistent weakening of the rand. The currency weakens by an annual average of 5.5% versus the dollar. 

This makes importing goods into South Africa, particularly oil, more expensive and thus drives up prices in South Africa. 

Furthermore, the ongoing strength of South African trade unions tends to keep the overall wage increase at or above the top end of the inflation target. 

At the same time, the country continues to struggle with declining levels of productivity, which undermine the country’s competitiveness, adding a layer of costs that companies are constantly trying to recoup.