The Reserve Bank’s decision to leave the repo rate unchanged last week was expected, but the monetary policy committee (MPC) will struggle to explain taking the same position when it meets in September, unless authorities move to a lower inflation target.
In a 4.5% target world, the MPC should arguably have cut rates at its meeting last week. The Bank’s modelling team forecast that the consumer inflation rate will drift below its 4.5% target in the fourth quarter of this year and remain close to 4% through the second quarter of 2025. If, as the governor always tells us, policy is forward-looking, the more benign outlook for inflation into next year should matter more than recent inflation prints, which say more about where we have been than where we are going.
However, I can also see how not cutting was a reasonable decision. This MPC is of a more hawkish bent, and the argument that SA’s rates are low in the context of the real rates seen globally holds some merit. The US Federal Reserve is expected to start easing in September, and cutting with the Fed does lower the risk that a dovish move now could unduly increase inflation locally. It also anchors the inflation expectation.
The longer path for interest rates will also tell us a lot about how the MPC is thinking about its inflation target. The Standard Bank Research view is that the repo rate will drift down to 7.25% by the middle of 2025 and the market is priced for the same eventuality. If inflation is 4.5%, then 7.5% is the neutral rate. Given the weakness in the economy, a slightly expansionary monetary policy setting, where the repo rate settles below the neutral rate, appears appropriate.
That said, it is possible we are all underestimating the eventual depth of the easing cycle, probably because the factors we would all agree could push rates lower are still risks and not yet baked into expectations. The potential positive shock to growth from the removal of constraints, the most important of which is electricity supply, could see the emergence of disinflationary growth, the best kind of growth for monetary authorities.
Eskom will continue to ask for, and is likely to get, ruinous tariff increases. This risk was flagged by the MPC last week. However, the actual cost of power, increasingly the combination of the Eskom tariff and far cheaper own-generated renewables, will decline. Households and businesses use rooftop solar to satisfy some of their electricity needs, which explains low electricity demand and the absence of load-shedding.
Activity can, therefore, grow without the power cost escalations that would typically be associated with such growth, when said activity is not entirely dependent on Eskom-supplied electricity.
Another supportive factor could be that the US cuts rates far quicker than the 75 basis points (bps) into January that the market is now discounting. To the extent that SA rates cannot be too low relative to US rates, lest they undermine the exchange rate, Fed decisions are something of a constraint on the Reserve Bank.
Current expectations incorporate the idea that US growth will remain well supported even as that economy is showing increasing signs of strain. If the US economy slips into recession, the Fed would ease more aggressively, opening space for more cuts locally.
This, of course, is premised on the assumption that Bank governor Lesetja Kganyago does not get his way, and that the inflation target is not adjusted lower to his preferred 3%. The MPC could be reticent in cutting and use a lower inflation path as an opportunity to lock in a lower target. When the Bank moved from an effective target of 6% to 4.5% in 2017/18, it cut rates by a measly 50bps as inflation fell three percentage points to a low of 3.8% in 2018.
The Bank got its desired outcome as economic actors got the message and inflation expectations fell to 4.5%. Lowering the target would not result in monetary policy easing being cancelled, but it would imply a miserable and miserly cutting cycle.
• Lijane is global markets strategist at Standard Bank CIB.
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