Reserve Bank cuts repo rate by 25 basis points thanks to diminished risks

The Reserve Bank has decided to cut the repo rate by 25 basis points as economists expected, giving South African consumers some breathing room after the repo rate remained at 8.25% since May last year.

Lesetja Kganyago, governor of the South African Reserve Bank (Sarb) announced the reduction of 0.25% in Pretoria on Thursday afternoon.

The announcement followed a decision by the US Federal Reserve on Wednesday night to cut the US rate by 50 basis points.

“In discussing the repo rate stance, Monetary Policy Committee (MPC) members considered an unchanged stance, a 25 basis point cut and a 50 basis point cut. The MPC ultimately reached consensus on 25 basis points, agreeing that a less restrictive stance was consistent with sustainably lower inflation over the medium term.”

Although inflation decreased to 4.4% in August as announced on Wednesday, Kganyago says this did not matter much.

“What matters is what inflation will do going forward. We must have the right policy stance in that regard and consider all the risks that inflation can increase again.”

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Global inflation and interest rates impact on repo rate

Kganyago pointed out that global inflation is slowing and nearing targets towards the end of the year. “Given these gains, major central banks have lowered rates. We saw the European Central Bank cut again last week, the Bank of England eased in August and the US Federal Reserve reduced rates last night.”

He also pointed out that the US dollar also cooled off in recent months, providing some respite for other currencies, including the rand.

However, despite these welcome developments, Kganyago says central banks are moving carefully and policy stances remain relatively tight. “Economic activity in major economies has been resilient, even as inflation eases. Underlying measures of inflation have also fallen less than headline inflation, primarily because of elevated housing inflation and robust wage growth.”

He says the case for caution is further bolstered by the difficult and unpredictable geopolitical environment, with risks of inflationary shocks such as trade restrictions and supply chain disruptions.

“Overall, global conditions have become more favourable, but there are still risks. A ‘soft landing’ is looking more likely, after the worst inflation surge in a generation, but it is not inevitable. The financial market volatility of early August was a reminder of the fragilities and uncertainties in the system. Therefore, central banks are approaching the endgame with caution.”

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South Africa sees rising confidence for growth

Turning to South Africa, Kganyago says output was marginally below the Sarb’s expectations for the first half of the year. “We expect improvements in the second half, with growth of 0.6% in both quarters. This reflects rising confidence, in part due to a stable electricity supply.

“We also expect extra spending given withdrawals from the new two-pot retirement system, although some of these funds will be absorbed by debt repayments and tax.”

The Sarb’s growth projections for the medium term once again edged higher. Kganyago says this is thanks to better-functioning network industries, especially electricity, alongside broader reform momentum.

“Because potential growth is higher in the forecast, supply and demand remain broadly balanced, even as growth accelerates. The pace of growth nonetheless remains below longer-run averages of around 2%.”

He says investment is a particular concern as it has been contracting for four consecutive quarters. “A stronger investment performance is a pre-requisite for sustained higher growth and although we continue to expect an investment recovery, its scale and speed will be a key indicator of South Africa’s longer-run economic prospects.”

According to Kganyago, the risks to the growth outlook are assessed as balanced.

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Inflation expected to keep easing

He says inflation easing to a three-year low of 4.4% in August is close to the middle of the Sarb’s target range. “Our forecast suggests this progress will be sustained, with inflation contained below the 4.5% midpoint of our range through to the end of the forecast horizon in 2026.”

In the near term, the Sarb continues to see a dip in headline inflation, supported by the stronger exchange rate and lower oil prices. Kganyago says the implied starting point of the rand is R18.04 to the US dollar, an appreciation of nearly 2% relative to its July assumption.

“This contributes to fuel price deflation, which helps keep headline below 4% through the first half of next year. As usual, we will look through this near-term supply shock, focusing on the medium-term outlook.”

In addition, lower headline inflation also reflects a better food price outlook, he says, with inflation for this category below the midpoint through 2025 and 2026. However, he noted that these benefits are partly offset by higher electricity prices, with an expected inflation rate more than double that of headline inflation.

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Core inflation expected to be slightly below 4.5%

For core inflation, the Sarb expects the trajectory to be slightly below 4.5% over the medium term. Again, he says, this is primarily due to the exchange rate which affects core mainly through import prices.

The Sarb expects that services inflation will stabilise near the midpoint early next year, after a stretch of prints above 4.5%. “This partly reflects subdued housing inflation, which has accelerated less than expected this year. Lower inflation expectations also contribute to the improved services outlook.”

According to the latest survey, these expectations are still in the top half of the target range, at 4.8% for both 2025 and 2026, Kganyago pointed out. “They are nonetheless moving – slowly – in the right direction. As long as headline inflation stabilises at lower levels, we anticipate further progress in re-anchoring expectations around the middle of our target range.”

Therefore, the MPC assessed the risks to inflation as balanced. It is against this backdrop that the MPC decided to reduce the repo rate by 25 basis points to 8%.

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MPC considerations for repo rate cut

The forecast sees rates moving towards neutral next year, stabilising slightly above 7%, Kganyago says. “As before, the rate path from the Quarterly Projection Model remains a broad policy guide, changing from meeting to meeting. Decisions of the MPC will continue to be data dependent and sensitive to the balance of risks to the outlook.”

He says there are scenarios where inflation could undershoot the baseline forecast if oil prices are lower or the exchange rate appreciates further. On the other hand, inflation could be higher than the baseline forecast given scenarios such as higher housing costs, larger electricity price increases, or wage increases that outrun inflation and productivity growth.

Meanwhile, food inflation is a source of uncertainty, despite recent improvements, he says.

“Global conditions pose additional challenges. Geopolitical risks are heightened and could generate further economic shocks. Policy uncertainty is also elevated in various parts of the world. Both trade restrictions and debt levels are rising and might go much higher.

“This mix could add significant inflationary pressure to the world economy, generating tighter financial conditions for South Africa and other countries,” Kganyago warns.

The MPC’s main contribution is to deliver low and stable inflation, with well-anchored inflation expectations.

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SA assets performing well for now

For the time being, he says, South African assets have performed relatively well. “The rand has strengthened during the year, more than most peer currencies, while long-term yields have moderated and spreads over US rates have narrowed. These moves have reversed some of the deterioration experienced since 2020.”

However, he says, given a potentially adverse external environment, it is crucial to sustain domestic reform momentum. This entails both structural reforms to support growth capacity and macroeconomic efforts to rebuild fiscal and monetary buffers.

“We also recommend additional measures that would improve economic conditions. These include reaching a prudent public debt level, further repairing and strengthening network industries, lowering administered price inflation and keeping real wage growth in line with productivity gains.”