The following is a case study in monetary policy. The economy to be investigated is stagnant. Very little growth in GDP is being recorded. Spending on capital goods, plant and equipment is even more subdued than spending by households. Demand for bank credit has not grown in real terms for a number of years. Indeed, it is still below pre-Covid-19 levels, as is economic activity.
Not all of the news is bad. Inflation is well down — prices have hardly increased for six months. But short-term borrowing costs have lagged well behind the declining inflation rate. The difference between the interbank lending rate for three months and annual inflation — real rates — is 4.4 percentage points, a gap not approached since 2003.
It would seem perfectly obvious that the appropriate policy response would be to cut the key repo rates immediately and significantly, to stimulate much-needed spending growth, for which interest rate settings are a significant discouragement.
As readers will have guessed, the economy in question is SA. The charts tell the story. Yet the Reserve Bank has successfully guided the money market to expect little by way of interest-rate relief. The forward rate agreements between banks indicate that short rates are expected to decline by no more than 50 basis points over the next 12 months, and that even a cut of 25 basis points at its meeting this week is considered unlikely. This reluctance of the Bank to do what would be obvious to most is what makes this case study particularly compelling.
Some further facts might illuminate the case further. Why, it should be asked, has inflation come down so dramatically in SA? It is because spending (the demand side) remains depressed and because the supply side of the price equation has been especially helpful over the past year. It must be so given that exports and imports directly affected by the cost or value of foreign exchange are equivalent to 60% of GDP. And the rand has been unusually muscular.
Where the exchange rate goes, so go prices — as has been the case in recent years. Rand weakness in 2023 led prices and inflation higher — and interest rates followed. Then strength in the rand since early 2024 helped largely stabilise the prices of imports and the consumer price index (CPI) since mid-2024.
How then does one explain the behaviour of the rand — the single most important influence on the CPI? The introduction of the government of national unity (GNU) improved the outlook for structural reforms and faster growth in GDP — and so improved the case for investing in SA, to the benefit of capital flows and the rand.
The biggest threat to fiscal sustainability in SA and its bond market, and so to the level of longer-term interest rates and debt service costs, is the absence of growth. Slower growth expected means a weaker rand and more inflation, and more inflation expected and higher borrowing costs. And vice versa. The Reserve Bank contributes to growth via the influence of its interest rate settings on demand. The exchange rate, and therefore inflation, are not under its direct control
No doubt we will learn from the Bank about the global risks it has to contend with. But these are risks over which it has no predictable influence, or the ability to confidently predict. Parliament and its decisions about the allocation of taxpayers’ money, especially to capital expenditure, will dominate the immediate outlook for growth and the rand.
Expected inflation has declined only marginally in recent months. Yet again this will be given by the Bank as a reason for not lowering interest rates further. But expected inflation can only recede with persistently lower inflation. That can only come with persistent rand strength. It, too, is beyond any direct control by the Bank.
The Bank’s focus should be on managing the demand side of the economy — using its interest-rate setting powers to prevent too much spending that might lead prices higher, and to avoid too little spending that would depress growth. That now means lower interest rates. It is simple logic.
• Kantor is head of the research institute at Investec Wealth & Investment. He writes in his personal capacity.
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