Inflation and interest rate relief still on the cards

While interest rate cuts have been under way for some time in several of South Africa’s emerging market peers, South Africans are not yet enjoying such relief, and nor is a cut likely to be announced at the next interest rate meeting later in May. Indeed, the domestic interest rate trajectory remains subject to elevated forecast risk, which recently flared up to such an extent that the money market swung from foreseeing rate cuts to hikes instead. Though these changes (in inflation drivers and interest rate expectations) have since reversed, they showed the elevated, and broad-based, forecast risk from factors ranging from the elections and crop estimates to geopolitical warfare and global interest rates.

While the adverse inflation and interest rate risks persist, there has been growing support for our expectation that the Reserve Bank will have implemented interest rate relief by the end of the year. This notably includes the persistently weak housing market, as confirmed again recently when the Rode property report estimated that flat vacancies (at 7.9% in the first quarter of 2024) remain well above pre-pandemic levels (which averaged 5.3%). A weak housing market suppresses rental inflation, which is influential for interest rates because it is a weighty part of the consumer inflation basket targeted by the Bank and because it is a popular barometer of demandpull inflation. Accordingly, this state of affairs provides important confirmation that demandpull inflation remains contained.

Also, concern about a possible food inflation spike in response to drier and hotter weather in February and March has eased materially recently, with largely maize crops and prices significantly affected, as we expected, but other food prices remaining rather contained. Thus, price pressure in the two largest components of the inflation basket — rent and food — remains subdued.

More importantly from a monetary policy perspective, and in addition to the housing market weakness, there are clear indications consumer demand is too weak to fuel inflation. This includes, notably, lower real (in other words, after adjusting for inflation) retail spending and private sector credit relative to a year earlier. Indeed, our data tentatively reflects a broadening of the financial pressure that was previously concentrated among low- and lower-middleincome earners. Wage settlements also seem to have remained quite steady, even when headline inflation spiked. Furthermore, surveyed inflation expectations have drifted lower and are at levels at which the Bank cut rates in previous cycles. The inflation forecast trajectory remaining inside the Bank’s 3%-6% target range throughout the forecast period creates scope for it to cut rates. However, while the persistence of inflation and interest rate risks don’t derail the prospect of rate relief, it likely delays the expected cuts.

That is because a pragmatic central bank will, in the current setting, cut interest rates only once it is confident about inflation reaching the midpoint of the 3%-6% target band relatively soon, and sustainably. Two particularly impactful risks about which the Bank requires more certainty before acting are the outcome of the upcoming elections and the onset of the Federal Reserve’s rate-cutting cycle.

The next inflation data for April is likely to drift sideways at about 5.4% from 5.3% in March. Indeed, we expect inflation to remain quite “sticky” at about 5.5%—5% throughout the second and third quarters of 2024, then easing to 4.5%—5% from the fourth quarter of 2024 on a sustainable basis. This relatively sticky inflation trajectory is a key reason for monetary policy relief being more delayed in South Africa than many of our emerging market peers.

We still foresee rate relief in South Africa from later this year (100 basis points of cuts from the third quarter of 2024), but the forecast onset of the interest-rate-cutting cycle has been pushed out repeatedly. This is a notable setback for consumers also confronting headwinds from fiscal drag announced in the budget, as well as limited growth in total compensation of government employees.

These headwinds are counteracted by the strong tailwinds of lower inflation (expected to average 1% less in 2024 than in 2023) and the employment recovery in the second half of 2023. From an economic growth perspective, too, a further delay in the expected rate relief is a material setback — but this is counteracted by the improvements in the (electricity and logistics) infrastructure constraints. We therefore still expect a gradual recovery in economic growth this year, which could even be more than double last year’s 0.6%, despite the numerous delays in the much-anticipated interest rate cutting cycle.