Although South African consumers are struggling, ill-timed interest rate cuts could have dire consequences.
Since the end of 2021, the South African Reserve Bank has fought inflation by increasing the repo rate by 4.75 percentage points to 8.25% – the highest level in 14 years.
However, there are now signs that the SARB could start cutting interest rates, with the potential for it to start doing so before the US Federal Reserve does.
Stanlib Senior Economist Ndivhuho Netshitenzhe said South Africa would not be the first emerging market to cut rates before the US, with Brazil, Chile, Peru, Vietnam, Poland, and more already cutting rates this year.
“Latin American central banks are at the forefront of the current cutting cycle amid significantly slower inflation. For example, in July, Chile was the first major emerging market country to reduce interest rates as its inflation eased from 14% in August 2022 to 5.1% in September 2023,” Netshitenzhe said.
When global inflation skyrocketed in 2021, several Latin American central banks were the first to raise interest rates before the US Fed began tightening. These nations were far more aggressive than the US, with Brazil increasing rates by 11.75 percentage points compared to the Fed’s 5.25 percentage points.
Although the SARB has been less aggressive, it also started its hiking cycle before the US.
“It justified the move as necessary to prevent inflation from moving back to the top end of the inflation target unchallenged and thus undermining gains in getting inflation expectations lower,” Netshitenzhe added.
“SA’s inflation rate peaked at a much lower level than that of the US and many Latin American countries… This not only meant that the SARB did not need to be as aggressive, but it also meant that the path back to target was much shorter.”
Despite currency fluctuations and pressure on wages, South Africa’s headline inflation has been within the SARB’s target range of 3% to 6% since June. The nation’s long-term inflation expectations have also dropped since peaking in Q2 2022, implying that South Africa has won the battle with inflation.
Danger from cuts
That said, cutting interest rates comes with severe risks, with those who cut this year facing consequences for their decisions.
“Cutting rates before the Fed does means a narrower interest rate differential, thereby reducing the compensation investors receive for taking emerging market country risk. This leaves emerging markets vulnerable to currency weakness and increased financial market instability,” Netshitenzhe said.
“The currencies of major emerging markets that have cut rates this year have, in general, had a weakening bias since their first rate cut. For example, the Chilean peso has weakened by 11% since July and the Brazilian real by 5% since August 2022.
“In addition, 10-year bonds for Brazil, Chile, Peru and Poland have been more volatile since the respective cutting cycles started.”
The extent of currency and financial market vulnerability differs between countries, but the SARB is keeping an eye on all markets to see how the market would respond if it cut rates before the Fed. If the decision is seen as appropriate, the negative market reaction will likely be restrained.
Additionally, there is a risk that the SARB will cut rates before inflation is under control, as the latest data shows that there is an upside risk.
Food price inflation remains high, and there are concerns that electricity and fuel price increases could increase core inflation in the months ahead.
“If the SARB were to cut rates during this time, it risks keeping inflation at an elevated level for longer and undoing the progress made in getting inflation expectations lower,” Netshitenzhe said.
“Fortunately, current upside risks to inflation appear likely to be contained, given already-high interest rates and a sluggish economic environment that makes it more difficult for companies to pass on cost increases. This is why headline inflation is likely to continue to moderate next year, ending 2024 at 4.6%.”
“This should give the SARB room to start cutting rates in the second half of 2024, irrespective of the policy decision made by the major central banks, including the Fed.”
That said, the SARB may cut rates gradually until the global interest rate-cutting cycle is clear to see. If the SARB jumps the gun and is too aggressive in its interest rate cuts, the rand could weaken further, adding unnecessary market volatility.
No short-term relief
Although interest rates should be cut from next year, South African consumers may be in for another hike in the coming weeks.
The Bureau for Economic Research (BER) said that the early resignation of SARB deputy governor Kuben Naidoo increases the chance of another interest rate hike.
“The departure of a deputy governor means the SARB’s interest rate voting committee shrinks to four members,” the BER said.
“Although this is still a quorum, it does make the possibility of a deadlock on the MPC more likely, especially given that the last two policy interest rate calls to keep the repo rate unchanged were decided by a 3-2 split.”
“In a 2-2 split scenario when there are only four members, SARB Governor Lesetja Kganyago would cast the deciding vote,” the BER said.
Although Naidoo was seen as a dove – tending to support low-interest rates and an expansionary monetary policy, Kganyago is seen as a hawk – primarily focused on tackling inflation.