The downside of interest rate cuts

South Africa’s improved inflation outlook and recent interest rate cuts have earned praise and are set to provide consumers with some relief – but some people will benefit more than others.

Reserve Bank Governor Lesetja Kganyago recently offered a mixed outlook on inflation. On the positive side, he expressed optimism that inflation would remain low in the short term.

The Reserve Bank’s forecast expects inflation to average 4% next year and hover around the 4.5% target in 2026 and 2027.

“Over the long term, lower inflation would benefit the country, as it will result in lower interest rates over time, less rand depreciation, and a more stable business environment,” Old Mutual Wealth Investment Strategist Izak Odendaal said.

“However, the adjustment phase could be uncomfortable in the sense that interest rates might be higher in the short term than would be the case otherwise.”

“For instance, if the target is officially 3%, then next year’s inflation forecast of 4% would be unacceptably high, and there would be no room to cut rates further.”

That doesn’t mean there would have to be rate increases, however, Odendaal explained.

“A repo rate of 7.75% and inflation of 4% would still imply a real repo rate of 3.75%, which the bank would consider as ‘restrictive’.”

“The Reserve Bank assumes a real repo rate of around 2.75% is ‘neutral’. Anything above is believed to be a drag on domestic demand, while a level below is stimulative.”

Despite decreasing inflation – with October’s CPI being 2.8%, down from 3.8% in September, and well below the Reserve Bank’s target range midpoint of 4.5% – potential headwinds remain.

Owen Khumalo, CEO of Weaver Investment Management, told SABC News that geopolitical tensions, in particular, including US-China trade issues raised by Donald Trump, could trigger inflationary pressures.

This outlook was reflected in the Reserve Bank’s most recent interest rate cut, as the central bank erred on the side of caution, Khumalo explained.

Although many people expected the bank to reduce interest rates by 50 basis points in September, following the Federal Reserve’s decision in the US, they opted for a 25 basis point reduction instead, which they followed again in November.

This means that since September, the Reserve Bank has reduced rates cumulatively by 50 basis points, mirroring global trends but remaining conservative.

Looking ahead, interest rate cuts are expected to continue but remain modest at around 25 basis points.

The Reserve Bank is likely to pause and evaluate data before making further adjustments, prioritising caution to mitigate risks of future inflation spikes or economic instability.

According to Khumalo, these cuts will have both positive and negative impacts on consumers.

“For those consumers that are paying off debt – like home loans, car loans, credit cards – it’s good news.”

This is because, for those with variable interest rate loans, interest rate cuts translate to lower monthly repayments, which provides some relief for individuals managing debt.

For example, Khumalo noted that for a home loan of approximately R1.5 million, the cumulative effect of these rate cuts since September could result in monthly savings of around R500.

According to Stephen Whitcombe, MD of the Firzt Realty group, the latest rate drop represents a monthly repayment reduction of just R17 per R100,000 of a 20-year bond borrowed at prime.

While this might not seem significant, it adds up to R172 a month on a R1 million bond and R343 a month on a R2 million bond.

“This comes on top of the repayment reductions brought about by the 25 percentage point interest rate cut in September and will undoubtedly make it easier for potential homebuyers to qualify for home loans and afford the monthly repayments,” Whitcombe said.

“On a first-time-buyer home loan of R750,000 borrowed at prime, for example, the qualifying income is now around R26,200, compared to just over R27,000 in August, and the minimum monthly repayment is now R7,870, compared to R8,130.”

However, Khumalo explained that these interest rate cuts also have some drawbacks for other consumers.

Investors who rely on interest-bearing investments to fund their income will earn slightly lower interest on their investments.

This will affect retirees, in particular, who rely on interest-bearing investments like bonds and money market accounts.