Interest rate relief is on the way, but mind the rand

Recently, we have seen the beginnings of an interesting debate between economists and money market investors about the timing and depth of the much-anticipated interest rate-cutting cycle in South Africa.

The consensus expectation of economists polled by Bloomberg is for the Reserve Bank to cut rates by a cumulative 1.25 percentage points, possibly starting as soon as the current economic quarter.

In sharp contrast, the money market has shifted towards a later, and shallower, cycle, now discounting cuts of only 50 basis points (bps) in the next 12 months and starting only from November. We are positioned between these two trajectories: we foresee 100bps of cumulative rate cuts, in 25bps increments, from the July 2024 MPC meeting.

In our view, the cuts hinge on the inflation forecasts and risks: the Bank is likely to cut rates only once it is confident about inflation reaching the mid-point of its 3%-6% target band relatively soon, and on a sustained basis.

Based on our current view, inflation forecasts taken in isolation should allow for prudent interest rate cuts quite soon — despite the Bank’s emphasis on the forecasts sustainably reaching 4.5% only by the fourth quarter of 2025. The SARB’s inflation forecasts are from the fourth quarter of 2024 sustainably no more than a marginal 0.2% away from this goal.

We therefore see scope for the Bank to start cutting rates prudently from the July MPC meeting when it would be effectively a mere quarter away from its goal — a very short period for a forwardlooking central bank, given the delay in monetary policy decisions filtering through the economy.

This, however, is premised on the Bank’s prevailing inflation forecasts (which mirror ours as well as the median of polled economists). But the spanner in the works is elevated risks. Indeed, the rand exchange rate is, in our view, the biggest threat to the relatively benign inflation trajectory and so the forecast interest rate cuts.

The most prevalent currency risks are twofold. Globally, the timing and pace of rate cuts — by the US Federal Reserve in particular — reflect both the intensity and prognosis for global inflation, and influence South Africa’s interest rate differentials.

As Bank governor Lesetja Kganyago reiterated during the most recent post-MPC press conference: the Bank doesn’t “follow” global central banks (the Fed in particular) but rather monitors their decisions. Still, the Bank is likely to be most comfortable with a rate cutting cycle that broadly coincides with the Fed’s. Currently, the consensus is for it to cut rates from the middle of this year, which would broadly coincide with the onset of the cycle we envisage for South Africa.

Locally, the general election on May 29 is a potentially pivotal event. The high uncertainty regarding its outcome and impact effectively rules out a rate cut at the MPC meeting on May 30 (before the election results would have been declared). Should the outcome support general policy continuity, the rand might appreciate as the current risk premium should compress.

However, the currency is perhaps only partly discounting the risk of an outcome that steers policy in a more populist direction, which would put the government’s commitment to fiscal consolidation at risk. In such a scenario the rand could weaken markedly, thereby stoking inflation. That would not only negate the potential for lower rates, but could even put hikes on the table.

Other risks, such as the recent resurgence in food prices, are less likely to alter the inflation and interest rate prognosis materially. Despite the adverse impact of the drier and hotter weather in February and March on maize prices, we still foresee a gradual, though possibly stickier, moderation in food inflation in the months ahead.

At the last MPC meeting, Kganyago reiterated the MPC’s desire to anchor (surveyed) inflation expectations closer to the mid-point of the target range. Previously, under otherwise similar growth and inflation prognoses, the Bank lowered interest rates when longer-term inflation expectations were even marginally higher than they are now.

The bottom line is that there is scope for some interest rate relief from around July. At a minimum, however, this would require more certainty on the key upside risks to the forecast inflation trajectory.