The path to repo rate cuts ahead of Thursday’s announcement

While South Africans are waiting for the election results, all consumers with debt, such as home loans or car financing, as well as retail accounts and credit cards, are waiting to see what the decision about the repo rate will be on Thursday.

The Monetary Policy Committee (MPC) of the South African Reserve Bank (Sarb) is currently meeting and the governor of the Sarb, Lesetja Kganyago, will announce its decision on Thursday afternoon. The Sarb left its repo rate unchanged at 8.25% at the March meeting of the MPC, noting a delay in the path of inflation back to the mid-point of its inflation target and upside risk to the inflation outlook.

The Sarb also highlighted elevated two-year ahead inflation expectations in the upper half of the inflation target range and adverse weather conditions, which could lift food price inflation, Arthur Kamp, chief economist at Sanlam Investments, says.

“Subsequently, the release of the April 2024 consumer price inflation data suggests disinflation is on track. Admittedly, the annual advance in headline inflation did not change much, edging lower from 5.3% in March 2024 to 5.2% in April 2024.

“However, core inflation slowed from 4.9% to 4.6% over the same period and is now just about in line with the Sarb’s target. This seemingly makes things more interesting ahead of the May 2024 MPC interest rate decision.” 

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Lingering inflation risk and election are factors in repo rate

However, he says, given lingering inflation risk and uncertainty around the upcoming election, the Sarb is not expected to cut its repo rate this month. The question is what must happen to kick-start a domestic interest rate cutting cycle?

Firstly, Kamp says, a sustained period of rand stability would go a long way towards anchoring actual inflation and inflation expectations at a suitably low level in South Africa’s small, open economy. “Considering this, it will be important for government to continue with economic reforms, while pursuing prudent monetary and fiscal policies after the election.”

One consideration is the sustainability of fiscal policy, he says. “After all, unsustainable fiscal policies have often been the root cause of excessively high inflation episodes around the world. Importantly, the reappointment of Kganyago as governor of the Sarb for a third term is a welcome development as it points to monetary policy continuity.”

Secondly, Kamp says, it would be helpful if the US Federal Reserve cuts its policy interest rate significantly. “The Fed matters since we benchmark off the US risk-free interest rate. US interest rate hiking cycles are typically associated with weaker currencies and higher interest rates among emerging market economies and vice versa.”

Kamp says the Fed is likely to proceed cautiously, given resilient US gross domestic product (GDP) growth and a firm labour market, which may keep inflation above its inflation target for an extended period.

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US monetary policy quite restrictive

“Still, the Federal Funds Target Rate has been hiked a long way to a target range of 5.25% to 5.5% from a target range of 0.0% to 0.25% in early 2020. At the same time, the annual advance in the core PCE deflator has slowed substantially to 2.8% in March 2024 from its peak of 5.6% in February 2022.

“This implies US monetary policy is quite restrictive and there should be room to cut at some point, probably as from the second half of 2024.” 

Thirdly and most importantly, Kamp says, domestic inflation must slow towards the mid-point of the Sarb’s inflation target range. “Ultimately, this is the most important, although implicitly the Sarb does take the weakness of the economy into account considering the role the output gap plays in its modelling.”

Historically, the interest rate cycle has peaked once inflation peaks, he says. “We should therefore highlight that inflation peaked at 7.8% in July 2022 and has been on a disinflationary path, broadly speaking, since.”

He points out that it would also help if inflation expectations declined. However, typically expectations lag actual inflation outcomes.

“At the same time, real GDP growth is expected to be modest in 2024 and 2025, implying an output gap of virtually zero percent. Put differently, it cannot be argued that the economy is overheating and putting upward pressure on inflation.”

In addition, Kamp says, after adjusting for inflation, private sector credit extension is palpably weak and all of this indicates that South Africa’s restrictive monetary policy is having an impact.

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Uncertain future for repo rate

“The future is uncertain. Circumstances could change. An unexpected, sustained spike on soft commodity prices, for example, would be an unwelcome development. Policy changes could also have an impact.

“One possibility is an adjustment to the Sarb’s inflation target, which has been discussed in the media. If it is lowered, interest rate cuts could be more limited than expected as the Sarb adjusts to pursue a lower inflation rate.”

However, on balance, Kamp says, the information at hand suggests the repo rate should be cut significantly in response to slowing inflation as we head into 2025, once the Sarb is confident it is on track to meet its inflation target sustainably.

How deep is the interest rate cutting cycle likely to be? “The projections of the Sarb’s Quarterly Projection Model, which accompanied the March 2024 MPC statement, shows the repo rate at 7.72% in the fourth quarter of 2024 and 7.37% in the fourth quarter of 2025. We think that is as good an indication as any.”