Interest rate cuts coming – but there’s a catch

Nedbank has joined a chorus of other industry experts in forecasting 50 basis points of rate cuts for South Africa in 2024. While this will bring much-needed relief for consumers, the cutting cycle will likely be shallower than many may hope.

In its recently released interim results, Nedbank said the operating environment during the first six months of 2024 was challenging and economic activity remained weak.

It said the environment was impacted by geopolitical uncertainty, high interest rates, persistent inflation and general uncertainty ahead of the national elections in South Africa. 

“Household finances remained under pressure as real incomes contracted and job prospects remained muted,” the bank said. 

“Corporate activity was also weak on the back of the uncertain political and economic environment.” 

The bank said the financial implications of these difficult macroeconomic outcomes were evident in continued elevated levels of consumer strain and slow lending and transactional revenue growth across wholesale and retail clients. 

However, a peaceful and fair election outcome and the swift formation of a government of national unity (GNU) spurred cautious optimism in financial markets, resulting in lower bond yields, stronger equity markets and a stronger rand. 

Spreads on credit default swaps improved markedly, trending towards levels seen when the country’s sovereign credit ratings were at investment grade.

Against this backdrop, Nedbank said it remains cautiously optimistic about the potential benefits of South Africa’s GNU and expects better macroeconomic conditions in the second half of 2024 and into the medium-to-long term. 

The bank forecast South Africa’s gross domestic product to increase by 0.9% in 2024, inflation to continue to decline and the prime lending rate to decline by a cumulative 50 basis points in 2024 to end the year at 11.25%. 

With this prediction, Nedbank joins a chorus of other financial institutions and experts forecasting that the South African Reserve Bank (SARB) will start to cut interest rates as soon as the next Monetary Policy Committee (MPC) meeting in September.

Coronation economist Marie Antelme recently said the SARB is set to initiate interest rate reductions in the upcoming months. 

However, she warned this rate-cutting phase will be brief and modest, culminating in a final repo rate of 7.5% and a prime lending rate of 11%.

She explained that the Reserve Bank’s capacity to decrease interest rates is constrained by the government’s precarious financial standing and the possibility of a reduced inflation target.

The Reserve Bank has maintained a vigilant stance on South Africa’s inflation outlook, particularly given the persistent stickiness of food inflation. 

There is concern that a hasty or excessive rate cut could weaken the rand and potentially reignite inflationary pressures.

Should the Reserve Bank implement rate cuts ahead of the US Federal Reserve, capital is likely to flow out of South African assets toward markets offering superior risk-adjusted returns.

Nonetheless, the Federal Reserve has indicated its proximity to commencing interest rate reductions, with September being a probable starting point. 

In addition, weaker-than-anticipated US economic data has accelerated the timeline for potential rate cuts.

This development affords the Reserve Bank greater latitude to reduce interest rates at its upcoming September meeting, with Antelme predicting the initiation of the cutting cycle at that time. 

However, she expects a rate reduction of only 75 basis points, which would offer limited respite for South African households and consumers.

Considering the Reserve Bank’s cumulative repo rate hikes of 475 basis points since November 2021, a 75 basis point reduction is unlikely to significantly impact borrowing costs.

Such a concise and shallow rate-cutting phase would result in a repo rate of 7.5% and a prime lending rate of 11%. 

Antelme emphasised that the rate-cutting cycle will be circumscribed by the government’s weak fiscal position and the potential downward adjustment of the inflation target to 3% in 2025.

Stanlib chief economist Kevin Lings also said the Reserve Bank may begin cutting rates soon, but the cutting cycle will likely be short and shallow. 

He said that interest rates are likely to only come down by a cumulative 100 basis points in the next year, providing little relief for consumers.

Lings identified rising prices for administered services, such as electricity tariffs, as being a driver of inflation that is unlikely to come down in the next 12 months. 

For example, the cost of electricity averaged a growth of 15.2% year-on-year in the first five months of 2024 and has not been below 6% for many years. 

The cost of water rose by an average of 7.9% in the first five months of 2024, education by 6.1% and medical aid by 10.6%.

Thus, bringing inflation towards the midpoint of the Reserve Bank’s 3% to 6% target range is heavily dependent on limiting the increases in the price of basic services. 

Lings also highlighted the consistent weakening of the rand by 5.5% a year versus the dollar, which drives inflation by making imports more expensive. 

Another major factor in keeping inflation higher for longer is the repeated above-inflation wage increases for government employees and union members. 

This is coupled with declining labour productivity, which reduces South Africa’s competitiveness and increases the economy’s cost base.