RICARDO SMITH: A turning point for monetary policy

In a unanimous decision, the Reserve Bank’s monetary policy committee (MPC) decided to cut interest rates by 25 basis points. This is the first rate cut since the height of the Covid-19 pandemic in 2020 and marks a turning point for monetary policy, with more rate cuts expected to follow over the medium term.

This has been the trend globally, with the US Federal Reserve surprising markets and cutting by a more aggressive 50 basis points, while the Bank of England already cut earlier in the year and the European Central Bank recently followed up with their second cut for the year.

This is as we have seen inflation cooling across the globe, with energy prices showing signs of weakness and food price inflation subsiding despite drier weather conditions. Locally, we have also seen the rand strengthen as we begin to see more risk-on sentiment in the markets and easing political tension after a peaceful election, as well as progress made on reliable and sustainable energy supply.

The rate cuts come at a crucial time, as consumers and businesses were feeling the burden of a tough macroeconomic backdrop. Though these rate cuts will provide much-needed relief, more sustainable fiscal reforms are necessary to close our negative output gap in the long term.

The biggest challenge remains our dilapidating infrastructure. Transport and logistics continue to pose challenges to our growth. The balance between road and rail, as well as congestions in the ports, continue to create backlogs in our production processes and supply chains.

Coupled with these, the labour absorbing sectors such as construction, mining and manufacturing have been among the slowest-growing sectors over the past decade. This has meant unemployment has continued to rise to unsustainable levels, sitting above pre-Covid levels.

Furthermore, attraction and efficient allocation of capital has proven to be a challenge. Low levels of confidence have meant that gross fixed-capital formation, which is public and private sector investment into the real economy, has been low. The government’s biggest challenges have been revenue, struggling state-owned enterprises, wages and debt. We have been in a fiscal deficit since the global financial crisis in 2008, with the largest expenditure item being salaries and the fastest-growing expenditure item being the cost of servicing debt.

Notwithstanding these challenges, there are some green shoots in the local economy. Energy production is a major progress that we have made. Though we are yet to see the strong boost in economic output, this is in the pipeline as it takes time to filter to the broader economy from confidence to spending to compounding these positive benefits.

The two-pot system in retirement funds, which recently went live, is also expected to boost spending in the short-term from early withdrawals while creating long-term sustainable spending patterns from the inaccessible pot.

The rate cuts come as employment and production risks begin to outweigh inflationary risks, and as debt and refinance maturities fast approach, with credit loss ratios deteriorating and impairment charges increasing across the globe. Furthermore, particularly in the US, housing inflation, which remains a challenge, will potentially be solved by lowering interest rates, increasing house supply and reducing shelter prices. Locally, the rate cuts across the globe increase the room and scope for the MPC, as maintaining real rate differentials remains crucial as the bulk of our inflation is imported through the rand exchange rate.

While we welcome this change in regime, from a tight monetary policy to a more accommodative one, we would want to see more happening on the fiscal side of the economy. Furthermore, market reaction has been largely muted, as the bulk of the rate cuts were priced in already, with concerns now shifting to the lag effect between monetary policy decisions and economic impact.

• Smith is chief investment officer at Absa Investments.