The slow and steady interest rate-cutting cycle continued this week with the monetary policy committee (MPC) deciding unanimously to cut the repo rate by a further 25 bps to 7.75%.
At the previous MPC meeting in September, speculation was rife that the bank might cut by a more aggressive 50 bps. This was supported at that time by a marked lowering of the Reserve Bank’s inflation forecasts, then expected to stay below the 4.5% midpoint of the inflation target range for a protracted period (the 2025 inflation forecast average dropped to below 4.5% too). At that time, however, the Bank favoured a smaller (25 bps) increment partly owing to concern about multiple, and elevated, risks to the forecasts.
Indeed, the medium-term inflation risks have, in the Bank’s view, now escalated to such an extent that they are “highly uncertain, with material upside risks”. These risks, it says, include higher prices for food, electricity and water, as well as insurance premiums and wage settlements.
The Bank noted (in an understated fashion) that globally “new inflation pressures” and “heightened uncertainty” may create “risks of policy reversals” (reversing past interest rate cuts). Amid this confluence of inflation risks, the Bank pragmatically stayed the course of slow and steady interest rate cuts. With these risks unlikely to have been resolved by the next MPC meeting in January, a further modest (25 bps) interest rate cut is likely — unless the material upside risks to inflation materialise to such an extent that the Bank SARB is impelled to pause the rate cutting cycle. However, we view this as unlikely.
Other factors – including the potentially inflationary US fiscal and trade policy changes of the incoming Trump administration; the traction with domestic fiscal and growth reforms; and how geopolitical tension unfolds – will overshadow the impact on financial markets
The current weakness in inflation, and average 2025 inflation below the midpoint of the target range, implies some buffer to absorb additional inflation pressure without having to halt further interest rate cuts. While the Bank forecasts a gradual uptrend in economic growth and lifted its 2025 growth forecasts marginally, it is cognisant of the current pressure on the economy and consumers, with economic activity data quite subdued and mixed so far in the second half of this year.
Indeed, the fragility of the economy is one of the reasons we don’t expect the National Treasury to imminently announce a lower inflation target. This is notwithstanding governor Lesetja Kganyago’s stated preference for a lower inflation target and his indication during the Q&A session after the interest rate announcement that the “process with the Treasury” to contemplate lowering the inflation target “is coming to a conclusion”.
We still expect the Treasury to prioritise other difficult policy adjustments for now (such as the fiscal restraint to ensure that the government’s debt finally stabilises). Furthermore, some empirical research has flagged the possibility that a lower inflation target might be reached with minimal net cost to the economy, though there will likely be an initial negative impact that is followed by longer-term benefits. There is considerable debate about the likely growth impact, particularly in the near term. The Treasury would therefore likely favour delayed implementation of any lowering of the inflation target until such time that its immediate fiscal consolidation efforts might have been concluded and with growth firmly on a stronger footing.
We therefore don’t yet expect a lower inflation target to be a consideration in the near-term interest rate decisions. Despite the recent dip in inflation to below the inflation target range, at just 2.8% year on year in October, the bank’s forward-looking projection model became slightly more “hawkish”; it now foresees a trough in the interest rate cycle at about 7.25%, whereas this was closer to 7% at the previous meeting. This new forecast, however, is in line with our long-standing forecast that the bank will likely cut interest rates to 7.25%. This is the level at which interest rates are deemed to be “neutral” (having neither a stimulatory nor contractionary impact).
Financial markets also discounted a marginally higher interest rate trajectory after the MPC’s announcement and rather cautious rhetoric. Ultimately, however, other factors — including the potentially inflationary US fiscal and trade policy changes of the incoming Trump administration; the traction with domestic fiscal and growth reforms; and how geopolitical tension unfolds — will overshadow the impact on financial markets of the relatively narrow range of interest rate outcomes that are under consideration.
For now, we remain quite constructive about the prospects for the currency and fixed-income (bond) markets. However, as the MPC cautioned at last week’s meeting, “the risk outlook … requires a cautious approach”.
• Moolman is head of South African macroeconomic research at Standard Bank Group.
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