By: Johann Els, Old Mutual Group Chief Economist Why the Reserve Bank cut rates
The South African Reserve Bank’s Monetary Policy Committee (MPC) announced an interest rate cut of 0.25% yesterday. Inflation has eased considerably, with the headline rate dropping to 4.6% in July from 5.1% in June, comfortably within the SARB’s target range. Global economic factors, such as the US Federal Reserve rate cut this week, also added pressure on the SARB to take a more accommodative stance. With inflation under control and consumer demand remaining subdued, the environment was ripe for monetary easing, signalling potential relief for South African consumers and businesses.
According to Old Mutual Group Chief Economist Johann Els, the SARB will have room to cut rates again in November. “I expect interest rates to be cut, perhaps more than expected by the market,” Els noted, pointing to the combination of stabilising inflation and the absence of strong consumer demand pressures. The SARB has successfully brought inflation within its target range and with global pressures, particularly from the US, starting to ease, the path for a rate cut seems clear.
Another important consideration is the timing of the US Federal Reserve’s meeting, which occurred just one day before South Africa’s MPC meeting. The Fed lowered rates by 50 basis points, which set the tone for the SARB’s decision. The rate cut by the Fed should ease global financial conditions, supporting a stronger Rand and providing the SARB with further impetus to further reduce rates. Els highlights this connection, saying, “With the Fed likely cutting rates and local inflation pressures easing, the SARB should be confident in cutting rates going forward.”
Els also explains the intricacies of inflation, noting that while the year-on-year change in inflation shows a reduction, underlying price pressures have been weakening for some time. He points out that “the underlying pace of headline inflation over the last six months sits at just 3.4%, while the last three months show only 1.1%.” The corresponding numbers for core inflation are 4% and 2.8%. This downward trend indicates that inflationary pressures have significantly diminished, especially in core inflation, which excludes volatile items like fuel and food.
Despite these encouraging signs, Els cautions that inflation remains a long-term concern, particularly with fixed basket weightings that don’t capture changes in consumer spending habits. However, he remains optimistic about inflation continuing to fall. “Inflation could drop to around 4.1% in September and below 4% in October – possibly as low as 3.5%,” he said, adding that the SARB could reduce rates by 50 basis points in November, taking the repo rate to 7.5% by year-end.
For South African consumers, this would provide much-needed relief after enduring the highest interest rates in over a decade. Lower rates could spur economic growth, though structural issues such as labour costs and sluggish productivity gains continue to weigh on the economy. Els emphasises that while monetary policy can provide temporary relief, the underlying structural challenges remain a critical issue for long- term growth.
With inflation well under control and the Fed signalling rate cuts, South Africa seems poised for a reduction in interest rates. As Els puts it, “We’ve significantly turned the corner on inflation, and rate cuts must come.” All eyes will now be on the SARB’s meeting on 19 September to see if the central bank follows through on these expectations.
INSIGHT FROM ASHBURTON
Rate cut expectations: what the SARB and US Fed might do this week
By: Albert Botha, Head of Fixed Income at Ashburton Investments
A recent history of rates and rate cuts
The recent rate cycle has diverged significantly from the patterns of the past 30 years. The Fed hiked rates at the fastest pace in decades to combat the worst inflation in 40 years. These effects spilled over globally, resulting in higher inflation and rates worldwide, although not to the same extent as in the US.
At one point during the inflation spike, South Africa’s inflation rate was more than 2.6% lower than that of the US, a historically rare occurrence. Typically, South Africa’s inflation rate averages around 3% above the US rate.
This unprecedented rise in rates had significant consequences. Asset prices fell globally, investment flows into emerging markets reversed, and rates in economies worldwide rose in response.
In South Africa, the Repo rate (the interest rate at which a country’s central bank lends money to commercial banks) is at its highest level since the spikes of 2002 and 2008, with the current real repo rate 3.65% above inflation. This real rate exceeds the 2008 peak and is the highest since 2006. Over the last 20 years, the average real repo rate was 1.16%.
With inflation under control in South Africa, why hasn’t the SARB cut rates?
The answer once again lies in the US. Their recent inflation scare, slow progress in returning to target levels, and persistent economic surprises have prevented cuts. While South Africa’s real rate is relatively high, the difference between its real policy rate and that of the US is historically low, constraining the SARB’s actions significantly.
Current rate cut expectations
The Fed cut rates by 0.5%, with further cuts expected in 2024 and 2025, potentially lowering rates to at least 3.5% from the current 5.25%. This represents between 1.75% and 2.5% worth of cuts over the next 12-18 months.
The SARB has mirrored this rate path, with cuts expected to continue through next year. Projections suggest the Repo rate will bottom out between 6.25% and 6.75%.
Potential impact of expected rates changes
These changes will impact various sectors of the economy. For most people, this will provide welcome relief on home loans, credit cards and other debt. New homeowners can expect monthly payments to drop between R750 to R775 per R1-million loan size with the first 1% worth of cuts, while those with about 10 years left on their loans will see a reduction of R620 to R650 per R1-million outstanding.
For market participants, lower rates typically benefit riskier asset classes such as property and equity, particularly if South Africa’s socio-economic circumstances continue to improve. While fixed income funds may yield less in absolute terms, real returns remain attractive as local inflation continues to fall towards 4% or lower.
We are entering a new chapter in local and global markets, with lower inflation and falling interest rates. However, this era will likely differ from much of the last 20 years. Interest rates globally are expected to remain in positive real territory for the foreseeable future, unlike much of the recent past post the 2008 crises. These higher rates should better balance the needs of both borrowers and lenders, potentially leading to improved long-term outcomes for both.
