Finance

Threat to interest rate cuts in South Africa

Lesetja Kganyago

Repeated above-inflation increases in the price of electricity could prevent the Reserve Bank from significantly cutting interest rates. 

The Reserve Bank has been clear that increased administered prices, such as electricity, are a major driver of inflation in South Africa. 

These administered services, ranging from electricity to medical aid, are almost universal inputs into the economy. 

Thus, when the prices for these services are raised, it rases the cost base of the economy and keeps inflation elevated. 

Typically, the Reserve Bank would cut rates in response to poor economic performance to stimulate the economy and boost growth. 

However, inflation has remained elevated, forcing the Fed to maintain interest rates at 15-year highs for an entire year before starting its cutting cycle in September. 

While the Reserve Bank has some room to cut interest rates as inflation moderates to the midpoint of its target range, administered prices keep rising. 

Eskom asked regulator Nersa for permission to raise prices by 36.15% to cover the rising cost of producing electricity. 

The utility is requesting total revenues of R446 billion for the 2026 financial year, R495 billion for 2027, and R537 billion for 2028.

The proposed average price hikes for Eskom’s direct customers are 36.15% for the period from 1 April 2025 to 31 March 2026.

For the subsequent years, the utility is seeking increases of 11.81% from 1 April 2026 to 31 March 2027 and 9.10% from 1 April 2027 to 31 March 2028.

All of these increases are above inflation and will significantly increase the cost of production in the local economy. 

The Reserve Bank said in its latest Quarterly Bulletin that even before these price increases are implemented, administered price inflation accelerated to 8.9% at the end of the second quarter. 

The increases in administered prices are shown in the graph below. It is important to note the graph reflects the percentage change over the past 12 months. 

Stanlib economist Kevin Lings said administered price increases remain one of the biggest threats to interest rate cuts in South Africa. 

While interest rates will come down, administered price increases will result in them not returning to pre-pandemic levels. 

Lings said that declining inflation in several areas, from clothing to footwear to public transport, will not be enough to offset increases in the cost of key services. 

The prices of key services, predominantly public sector services, have increased above the recorded level of headline inflation and even above the upper end of the Reserve Bank’s target. 

While this is not necessarily bad if it is a once-off, the prices of administered services have risen consistently at considerable rates. 

This includes the cost of electricity, which averaged 15.2% 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%.

These percentage increases highlight South Africa’s continued difficulty in getting inflation consistently below the midpoint of the inflation target.

To bring the inflation rate fully under control, the government has to focus on controlling the cost increases of key essential services. 

Unfortunately, the extensive infrastructure backlogs the country is facing, coupled with the public sector’s severe fiscal constraints, suggests that administered prices will continue to escalate at a relatively rapid pace for many years, Lings said. 

In its Monetary Policy Review, released earlier this year, the Reserve Bank repeated its call for price increases on administered services to be limited. 

“These regulated, public sector-controlled prices impede efforts to bring inflation down and maintain it at the midpoint of the target band; consequently, they also erode competitiveness,” it explained.

“Electricity and water prices, in particular, have for several years inflated at rates well above the 4.5% midpoint of the inflation target band.”

“Efficiency gains in these sectors would be important to ensuring that long-run, cost-reflective prices are achieved soon,” it said.

“Other administered prices, such as education and assessment rates, are influenced by headline inflation outcomes and should be more closely aligned to the target midpoint itself.”

“Reducing headline inflation would bring down administered price inflation, creating a virtuous cycle.”

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