Bad news about interest rate cuts in South Africa

Despite inflation falling through the floor of the Reserve Bank’s 3% to 6% target range in March, its Monetary Policy Committee (MPC) is likely to keep interest rates on hold at its next meeting. 

South Africa’s headline inflation rate fell to 2.7% in March from 3.2% in February, taking it to the lowest level in four years and below economists’ expectations. 

This has led to speculation that the Reserve Bank’s Monetary Policy Committee (MPC) will cut interest rates at its next meeting in May and enter a rate-cutting cycle.

Bloomberg reported that traders increased their bets on the Reserve Bank resuming rate cuts in May, with markets indicating a 68% chance of a 25-basis-point cut. 

However, economists are not so sure the MPC will cut rates as uncertainty continues to roil financial markets, and an interest rate cut could make South African assets more vulnerable to external shocks. 

There are also indications that this is likely to be the low point for inflation in the coming years, with the next move likely to be upwards due to trade tensions and base effects. 

FNB senior economist Koketso Mano explained that these favourable base effects that have kept headline inflation low at the start of the year should begin to fade.

This implies that the MPC’s window to cut interest rates should narrow throughout the rest of the year as inflation rises towards the midpoint of its target range. 

Mano also pointed out that a turbulent global environment and risk aversion will likely continue to weigh on the rand and place some upward pressure on imported inflation. 

As price and wage setter expectations align with the Reserve Bank’s longer-term objective, there is less need for restrictive monetary policy, providing space for additional interest rate cuts in the near term. 

However, the conservative committee may choose to delay the resumption of the cutting cycle as global headwinds unfold.

At this stage, Mano sees higher odds of a premature end to the cutting cycle should global developments prove unfavourable, with the Reserve Bank even seeing scenarios in which interest rates must rise.

Elna Moolman, Head of South African macroeconomic research at Standard Bank, echoed this sentiment, stating that low inflation does not alleviate all of the Reserve Bank’s concerns. 

In particular, it does not remove the bank’s concerns around the upside pressure on inflation from global tariff developments and a potentially weaker rand. 

Reserve Bank concerns

Stanlib chief economist Kevin Lings outlined three significant reasons why the Reserve Bank may be hesitant to cut interest rates in the coming months. 

The Reserve Bank’s likelihood of keeping rates on hold comes despite it revising its economic growth outlook and inflation forecast for South Africa downward. 

The MPC’s last decision was not unanimous, with four committee members arguing for rates to remain unchanged and two members suggesting that interest rates should be cut by 25 basis points. 

Since September 2024, the Reserve Bank has cut interest rates by only 75 basis points, providing little relief to South Africans. 

The Reserve Bank’s conservative approach to monetary policy appears to reflect the combination of three key factors, Lings said. 

Firstly, it is concerned that a more aggressive cut in domestic interest rates would make South Africa more vulnerable to increased global risk aversion. 

This is because an interest rate cut would reduce the risk-adjusted return of South African assets, potentially resulting in money flowing elsewhere.  

Given heightened global trade policy and geopolitical uncertainty, this can result in pronounced currency weakness and higher imported inflation. 

Secondly, the Reserve Bank can reasonably conclude that South Africa’s low growth environment is not primarily due to the elevated level of interest rates. 

This means that cutting rates more aggressively would do very little to stimulate economic growth in the country without significant reform. 

Thirdly, the Reserve Bank would like inflation anchored around the bottom end of the inflation target at 3%, despite the midpoint of its target range being 4.5%. 

While a 4.5% inflation outcome is an improvement from prior years, it is not in line with global inflation targets and contributes to the rand’s steady weakening versus major currencies.