Inflation in SA has declined sharply from a 5%-plus rate in early 2024 to 2.8% per annum in April — for the usual supply and demand reasons. Demand for goods and services has been growing slowly and given rand stability — recently even absolute rand strength — the supply side of the economy has brought moderate increases in the consumer price index.
Bank lending to the private sector has been growing, albeit slowly. Adjusted for prices, bank credit is still below pre-Covid levels and after a spurt during Covid the real money supply grew by only 4.2% between 2021 and the first quarter of 2025. Recent growth rates in money and credit have trended lower. It is a financial state that can be described as severely repressive.
Given the weakness of demand for goods and services it is unsurprising that real incomes and output (GDP) were but 3% higher in the first quarter than in early 2019. When real demand grows as slowly as it has in SA real output could not have advanced at any faster rate than it has, meaning an expensive waste of a somewhat better growth opportunity.
The lack of demand for and supply of credit and money is explained by short-term interest rates set by the Reserve Bank. As inflation has fallen the real cost of borrowing for overdrafts or mortgages has risen to high, near record, levels. This is despite two highly delayed reductions of 25 basis points (bps), in the policy determined rate. The money market now predicts a mere 25bps further reduction in short rates over the next 12 months.
Without lower interest rates to encourage demand for bank credit and spending by households and firms, frustratingly poor GDP growth rates of less than 2% should be expected. The prospect of too little rather than too much spending (relative to potential supplies of goods and services) is likely to continue to weigh heavily on domestic producers’ pricing power. The demand side of the economy is unlikely to threaten higher prices for the foreseeable future without an unlikely change of mindset at the Reserve Bank.
Yet the unpredictable supply side of the SA economy, perhaps accompanied by a sharp reduction in the rand’s exchange value, could always drive prices higher. And judged by past performance the Reserve Bank would then drive interest rates higher to further depress demand that would come under pressure from higher prices.
Imports and exports account for a combined 60% of GDP. Their translation into rand prices depends on the exchange rate. The rand has been strong against the dollar, Aussie dollar and the emerging market basket recently. The import price index (with a large oil component) was falling in 2024.
Slow growth, aided and abetted by aggressive monetary policy, while disinflationary, threatens growth and fiscal sustainability. It discourages domestic capex, and capital inflows to fund it, that might have improved longer-term growth prospects. Expectations of slower growth capital away and tend to weaken the rand, and raise inflation rates.
Doubts that the government of national unity (GNU) would survive the arguments over the 2025/26 budget proposals led to some rand weakness. The agreement on the budget that was finally reached last month has reinforced the GNU and strengthened the rand. It is the supply side — the outlook for growth — that matters most for the rand and in turn inflation.
Long-term interest rates and their levels and differences with US rates have still to register any marked change in sentiment about the outlook for SA growth or inflation. Forward exchange rates still expect the rand to weaken at about 5% per annum over the next five years. Bond market yields — the difference between high vanilla bonds and elevated inflation-protected SA interest rates — indicate that inflation is still expected to average more than 6% over the next 10 years. That means expensive debt to add to fiscal strain.
Expected inflation and the cost of hedging the rand will not narrow and nor will borrowing costs decline meaningfully, absent any significant improvement in the SA growth outlook. But 3% per annum inflation in SA would be welcome and could be sustained absent any exchange rate shocks initiated by politicians, local and foreign.
Would setting a 3% inflation target mean more growth sensitive management of the demand side of the economy? Would it secure rand stability? Only possibly. It might, however, encourage the worst anti-growth instincts of the Bank to prevail, especially when the supply side of the economy — the exchange rate — does not play ball.
• Kantor is head of the research institute at Investec Wealth & Investment. He writes in his personal capacity.
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.