South Africans must prepare for higher for longer interest rates – but lower inflation

The South African Reserve Bank (SARB) has adopted a cautious and gradual approach to reducing interest rates and will likely only cut rates three more times in the next two years.

According to Investec chief economist Annabel Bishop, the SARB has a reason to be cautious in its interest rate-cutting cycle.

In its most recent Monetary Policy Committee (MPC) meeting, the central bank implemented a modest 25-basis point cut to the repo rate. 

This is despite inflation dropping to a low of 2.8%, well below the target range of 3% to 6%.

Before the decision, some experts called on the SARB to cut rates by more than 25 basis points, saying the country’s current economic state would justify a larger cut.

Old Mutual’s Johann Els urged the Reserve Bank to consider cutting rates by 50 basis points at its November meeting.

Els said this move would have been justified by the economic conditions underlying it. He also critiqued the SARB’s traditionally cautious stance, suggesting that the current environment provides a unique opportunity for more assertive action. 

“Given the shortfall in inflation recently and projections that it will remain subdued, a more substantial rate cut would align with the economic signals we are observing,” he said.

He warned that while prudent, the Reserve Bank’s cautious approach may not fully capitalise on the opportunity to stimulate economic growth at a crucial time. 

However, Bishop explained that the SARB’s decision to cut by only 25 basis points reflects its commitment to a forward-looking inflation-targeting approach.

This strategy seeks to control inflation in the future rather than reacting to current inflation figures.

She explained that the SARB’s inflation-targeting framework focuses on maintaining price stability over the medium term. It aims for an inflation rate of around 4.5%, the midpoint of its target range. 

Therefore, despite current inflation being below the target range, the SARB’s decision-making process is influenced by future inflation expectations. 

The bank forecasts that CPI inflation will average 4.0% next year and further moderate to 3.2% by the end of 2024. 

Inflation is expected to remain around 3.5% in Q1 2025, with slight increases to 3.7% by mid-2025.

Bishop said these projections signal that while inflation is expected to remain within a manageable range, the SARB has reason to be cautious. 

The inflation target period, running from Q4 2025 to the end of 2026, is expected to see inflation hovering around the midpoint of 4.5%. 

This is based on the assumption that there will be additional 25-basis point cuts in the repo rate in the coming years. 

In total, the SARB anticipates a 75-basis point reduction – likely three 25-basis point cuts – in the repo rate over the next two years, bringing interest rates down gradually without rushing the process.

Despite the positive inflation outlook and green shoots in South Africa’s economy, the SARB remains wary of potential risks to its forecast. 

The global economic environment plays a critical role in determining inflation in South Africa, and changes in external factors could disrupt the domestic economic landscape. 

For example, the depreciation of the rand and rising global interest rates could place upward pressure on South African inflation. 

The MPC has expressed concern that global economic shifts, such as an escalation in geopolitical tensions or higher oil prices, could exacerbate inflationary pressures.

Oil prices, in particular, are a key concern for the SARB. A disruption in global oil supplies, especially in light of the ongoing Middle East conflict, could lead to higher prices for petroleum products in South Africa, directly influencing inflation. 

Similarly, fluctuations in grain prices – impacted by global agricultural conditions and the Russia-Ukraine conflict – could further drive up food inflation, which constitutes a significant portion of the CPI.

The SARB also considers domestic risks, like changing weather patterns that could impact food production and the volatile nature of the rand, which can affect the prices of imported goods and commodities.

Given these factors, the MPC has stressed that its decisions will be made on a meeting-by-meeting basis, with no firm commitment to a specific interest rate path.

However, the SARB’s hawkish approach over the past few years can be seen as a strong sign that interest rates will likely be higher for longer.