The South African Reserve Bank’s Monetary Policy Committee is meeting this week, with the market widely expecting a rate cut of 25 basis points to be announced on Thursday.
However, some economists believe that, while a 25 basis points cut will bring some welcome relief to under-pressure consumers, there is room for an even bigger cut.
According to PwC chief economist for Africa, Lullu Krugel, and PwC economist Christie Viljoen, the MPC should be bold and offer up a 50 basis points cut on Thursday, especially when considering South Africa’s repo rate is estimated to be 100 basis points too high.
This is based on the ‘Taylor Rule’ calculation, named after Stanford economist John Taylor, which has often been used in rate adjustment debates to determine what the ‘right’ level for the interest rate should be.
Taylor formulated his equation in the 1990s to forecast interest rates and suggest how central banks should change rates to account for both inflation and economic growth.
Using the Taylor Rule, PwC’s Strategy& Economics estimates that the repo rate is currently around one percentage point too high, premised on inflation averaging 4.5% this year, real economic growth coming in at 0.7%, and – based on academic research – the country’s potential economic growth being around 2%.
“Of course, the ‘one percentage point too high’ calculation will vary from one economist to the next, depending on these assumptions,” Krugel said. “If, for example, the upper end of the 3%-6% SARB target is used as the inflation target, the repo rate would be calculated as being 1.7 percentage points too high.”
The SARB MPC has over the past year aimed for the 4.5% mid-point of the inflation target range – making this the more appropriate level for Taylor Rule calculations, Krugel said.
“The bottom line is that this kind of calculation highlights the criticism that the SARB has received in the past about being too conservative on interest rates, i.e. erring on the side of caution – and rather keeping rates higher than too low.”
PwC’s Strategy& Economics said that it believes the MPC will reduce the repo rate by 25 basis points this week, to 6.50%. However, is also believes that the SARB should be bold and rather make a 50 basis points cut to stimulate the local economy. This would reduce interest rates to the lowest level in almost four years.
Effect on consumers
A 50 basis points change in the SARB repo rate was often seen in the 2000s, but last observed in early 2014. Since then, the MPC has moved monetary policy in 25 basis points increments.
The monthly repayment on a R1 million home bond would decline by about R165 with a 25 basis points rate cut, and a more substantial R330 with a 50 basis points cut.
The R330 per month saved would result in the bond repayment declining to a level not seen since late-2015, when the repo rate was last at 6.25%.
“Cutting interest rates this week to a four-year low will definitely offer a short-term boost to the South African economy,” PwC said.