Threat to interest rate cuts in South Africa

The uncertainty created by a tight US presidential election may be enough to prevent the South African Reserve Bank (SARB) from cutting rates at its next meeting in September, delaying rate cuts until after the votes have been counted. 

Economists expect a 25 basis points cut at the Monetary Policy Committee’s (MPC) September meeting, with some even anticipating a larger cut. 

Interest rates have remained at 15-year highs over the past year as the Reserve Bank has been wary of entering a cutting cycle when inflation was not sustainably within its 3% to 6% target range. 

Furthermore, cutting interest rates too soon or too sharply may weaken the rand significantly and reignite inflation. 

However, the path to interest rate cuts in the coming months appears clear as inflation nears the midpoint of the Reserve Bank’s target range and the US Federal Reserve gears up to cut its rates. 

The latest inflation data from Stats SA indicates that pricing pressure has eased substantially in South Africa. 

Headline inflation came down to 4.6% in July and was crucially below the 4.8% median of economists’ expectations. 

The local currency is also in a much stronger position than previously, with the optimism around the Government of National Unity (GNU) boosting its value. 

This, together with the Fed’s looming cuts, means the Reserve Bank should be confident in starting to lower the repo rate at its next meeting. 

However, FirstRand’s Ashburton Investments thinks another factor may prevent the Reserve Bank from cutting interest rates soon – the US presidential election. 

The asset manager also sees continued disinflation, supported by positive base effects and a stronger rand. 

Due to downside surprises in monthly outcomes, Asburton’s average headline inflation projections have been reduced to 4.9% this year from 5% previously and are more firmly at around 4.5% over the forecast period.

“We anticipate at least a 25 basis points cut, but the timing remains challenging,” it said. 

“While a September cut is highly probable, the US elections could provide the kind of market volatility that a conservative Reserve Bank may want to see through before cutting.” 

Ashburton also expects the interest rate-cutting cycle to be shallow, providing some relief to consumers but not alleviating all pressure on households. 

The asset manager expects the repo rate to only come down to around 7.5% over the medium term.

This represents a 75-basis-point cut from the 15-year high of 8.25% where the repo rate currently stands.

Its comments echo those of some economists who think that inflation and, thus, interest rates will be structurally higher in the coming years. 

South Africa’s economy has some fundamental drivers of inflation that keep prices rising above the Reserve Bank’s target range. 

Stanlib chief economist Kevin Lings singled out three of these key inflation drivers – administered services, a weakening rand, and rising wages. 

Administered services, such as electricity tariffs, are a major driver of inflation that is unlikely to come down in the next few years. 

Eskom has categorically stated that it will continue to apply for significant tariff increases as the price of electricity in the country does not accurately represent the cost of producing it. 

The cost of electricity averaged 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 as a significant driver of inflation. This is because a weak local currency makes 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. 

In addition, declining labour productivity reduces South Africa’s competitiveness and increases the cost base of the economy.