Interest rates may be higher for longer in South Africa

Following the US Federal Reserve, interest rates in South Africa may stay higher for longer as the decline in inflation in the world’s largest economy appears to have stalled. 

Old Mutual Wealth investment strategist Izak Odendaal explained that interest rates are still expected to fall in the coming year, but not by as much as previously expected. 

The change in expectations has been driven by the Fed’s higher-for-longer interest rate outlook in the US. This stands in contrast with the expectation that other major central banks will have to double down on interest rate cuts, Odendaal said. 

Despite other central banks, such as the European Central Bank and the People’s Bank of China, being likely to significantly cut interest rates, the Reserve Bank will follow the Fed’s lead. 

This is because the US remains the deepest and most important capital market in the world, with it having an outsized impact on financial markets. 

The decline in inflation we saw during 2023 and most of 2024 has stalled out somewhat. This is something the Federal Reserve will pay close attention to, but for now, has taken the view that the disinflationary trend will continue to zigzag lower. 

In a speech last week, Fed chair Jerome Powell noted he expected inflation to drift lower towards the 2% target but “on a sometimes-bumpy path”. He also noted that the resilient economy “is not sending signals that we need to be in a hurry to lower rates”. 

The Fed will likely cut a few more times but will proceed cautiously. It knows the Trump administration’s policies could be inflationary, but it cannot respond preemptively to plans that have not been implemented yet. 

For one thing, there is usually a lag between policy changes and their impact on the real economy, and these policies might not be implemented immediately or at all. 

There is a risk that there is a quiet period on the inflationary front where complacency builds on the part of investors and the Fed. 

What we do know is that market expectations for rate cuts have been scaled back considerably, Odendaal said. 

Futures markets price in a fed funds rate of 3.8% by the end of 2025, significantly higher than the 2.8% priced at the time of the jumbo September rate cut. This can be seen in the graph below. 

Odendaal said the Reserve Bank will keep a close eye on what the Federal Reserve does and will, most likely, take a more cautious approach. 

The Reserve Bank will be unlikely to want to cut rates faster or deeper than the Fed as this may result in a weaker rand as money flows to fixed-income assets with higher yields outside of South Africa. 

A weaker rand will, in turn, result in a higher cost of importing goods and potentially reignite inflation. 

For now, the Reserve Bank is likely to continue cutting the repo rate as domestic inflation is set to remain on target during 2025. 

The forecasts at the time of the September Monetary Policy Committee (MPC) meeting had a starting rand-dollar exchange rate of R18.04. 

Odendaal explained that the current exchange rate is about 1% weaker, but the oil price is about 3% lower, so there is little immediate risk of higher inflation.  

At any rate, the MPC was likely to be gradual in its cutting cycle irrespective of the US election outcome, so there is no reason to scale back what were already conservative expectations about the path of South African short-term interest rates. 

The repo rate still seems likely to settle around 7%, which is higher than it was pre-pandemic but nevertheless over 100 basis points lower than its peak. 

There are several other factors that will contribute to interest rates remaining higher for longer in South Africa. 

Coronation’s Marie Antelme noted that the Reserve Bank’s ability to cut interest rates is constrained by the government’s weak financial position and the potential for a lower inflation target.

Due to South Africa’s high debt levels, the country’s risk premium remains elevated.

This raises the cost of capital as the government’s declining creditworthiness impacts the financial system. Since banks cannot have a higher rating than their home country, their cost of capital also increases.

This, in turn, filters through the financial system, keeping inflation relatively high and more widespread.