Bad news about interest rates in South Africa

The Reserve Bank will likely keep interest rates unchanged at its next meeting amid elevated global uncertainty and concerns regarding the rand’s fragility. 

It is also likely to follow the US Federal Reserve, which has repeatedly said it would wait to see what effect US President Trump’s policies have on inflation. 

This is feedback from Old Mutual Wealth investment strategist Izak Odendaal, who outlined the Reserve Bank’s difficult position. 

The Reserve Bank’s Monetary Policy Committee (MPC) generally monitors developments in the United States, given its outsized influence on financial markets. 

This is even more true with Trump imposing tariffs, walking them back, and singling out South Africa in several outbursts. 

Odendaal explained that this has put the Federal Reserve in a very difficult position as the United States economy could face weaker growth and higher prices. 

Investors are increasingly concerned that the United States could enter a period of stagnation, where tariffs push prices higher while growth flatlines. 

As a policy tool, interest rates can only tackle one at a time, with cuts boosting growth while allowing inflation to run hot and interest rate hikes crushing growth while keeping prices stable. 

Higher import tariffs should result in only a once-off increase in prices, but the Federal Reserve has been clear that it cannot be sure. 

Inflation has been proving sticky in recent months in the US, with it yet to hit the Federal Reserve’s 2% target. 

The Fed will worry that higher goods prices could spill over into higher service inflation and, ultimately, higher inflation expectations. Odendaal warned that this could create a self-reinforcing cycle. 

Over the past two decades, goods inflation has mostly been negative, containing overall inflation levels. What lies ahead is difficult to know. 

The Reserve Bank has limited options

For other central banks in major economies, it is more straightforward as they do not have the inflation pressures that the Federal Reserve has.  

Odendaal explained that there is little reason to fear higher inflation in places like Germany, India, or Australia due to United States tariffs. 

On the contrary, all the goods previously destined for the US must now find a home elsewhere. This could be a disinflationary episode, especially considering the sharp oil price declines. 

Therefore, central banks can cut rates aggressively as they have room to let inflation rise in exchange for faster economic growth. 

The Reserve Bank’s MPC also has a relatively more straightforward decision to make when it meets next month, but for different reasons. 

In emerging markets with volatile currencies, like South Africa, central banks might worry more about exchange rate stability and hold off on interest rate reductions. 

The Reserve Bank is likely to wait for greater clarity over US trade and monetary policies for the next few months. 

The rand hovering at around R19 to the dollar could put some upward pressure on domestic inflation, but not much, given that the price of Brent crude has fallen faster than the rand. 

Meanwhile, the weaker currency will offset some of the impact of higher tariffs for local exporters.

The Reserve Bank would be concerned that an interest rate cut may weaken the rand further and perhaps more sharply. 

This would push inflation higher as it makes the cost of importing goods much more expensive. 

While the rand held its own for the first three months of the year, it is in a much weaker position now due to Trump’s tariffs and the instability of the Government of National Unity (GNU). 

Another less pressing concern for the Reserve Bank is that inflation in South Africa is likely to tick upwards in the coming months. 

The latest inflation data for February showed that the CPI rose by 0.9% month over month, which is very high by historical standards. 

Stanlib chief economist Lings explained that much of this was due to medical aid inflation, which rose by 10.5% year-on-year as medical aid schemes imposed their annual price hikes. 

Other areas where prices are rising quickly are electricity and water, where the government has imposed above-inflation price increases. 

Another driver of inflation is the price of education, which has consistently risen above inflation and remains above the Reserve Bank’s target range of 3% to 6%. 

Inflation in these areas will likely remain elevated as Eskom’s 12.74% electricity tariff increase took effect on 1 April. 

“What is helping us enormously is that there are areas, particularly in goods inflation, which remain especially low. Things like the cost of clothing, footwear, and appliances,” Lings said. 

“Many of these categories are in the range of 1% to 2% or are actually in deflation. Now that is unlikely to persist for much longer, so South Africa’s inflation rate will likely be above 4.5% by the end of the year.”