Interest rate pressure ready to burst

 ·26 Mar 2024

Major central banks have all kept interest rates on hold this month, with the South African Reserve Bank (SARB) expected to follow suit on Wednesday (26 March).

However, economists believe the interest rate pressure that has been building thanks to the long holds and “higher for longer” sentiment that has gripped the market over the past year is about to pop, and the cutting cycle will likely start in June – with South Africa also likely to follow soon after.

While markets initially anticipated an early start to the cutting cycle in 2024, stubbornly high levels of inflation around the world have severely dampened these hopes, with most analysts and economists shifting their ‘cutting’ targets to the second half of the year.

This “higher for longer” narrative led to a mixed forecast from economists and analysts, with the more pessimistic among them only penicillin in rate cuts in September 2024.

According to Azad Zangana, Senior European Economist and Strategist at Schroders, this target may be a step too far, noting that central banks in the US, UK and Europe are under pressure to ease policy.

The big three

The Bank of England (BoE), US Federal Reserve (Fed) and European Central Bank (ECB) all kept rates on hold this month, Zangana noted.

In some cases, this came as a surprise – for example, in the Eurozone, inflation returned to target at the two-year time horizon, but the ECB council decided to wait until more data was available that confirmed the improvement in inflation was likely to last, Zangana said.

The UK, meanwhile, is in recession, he said, and the BoE is facing mounting pressure to begin to ease policy.

“The (BoE) monetary policy committee’s language has shifted from a signal that interest rates would remain higher for longer, and essentially on hold for a prolonged period, to a signal that interest rates can fall, but remain restrictive,” Zangana said.

“While the UK’s MPC acknowledges the near-term easing of inflation pressures in the latest MPC meeting minutes, it also stated that indicators of the persistence of inflation remain elevated.”

Schroders had previously expected international rate cuts to start in March, but this has proven to be “too soon” for the central banks in question.

Zangana said the group’s view has now shifted to cuts from all three banks in June – which is in line with wider market consensus and the call for when the US Fed would start cutting rates,

“(The Fed call) is further supported by the outcome of the bank’s Federal Open Market Committee meeting last week,” Zangana said.

South Africa needs to be patient

The SARB’s policy moves are often directly tied to moves from central banks in bigger economies – not because it is inclined to copy what they do, but rather because of the impact these banks have on global economic conditions.

Investec chief economist Annabel Bishop previously noted that it is highly unlikely that the SARB would start a cutting cycle ahead of the US Fed, for example, as that would weaken the local currency significantly.

According to Arthur Kamp, Chief Economist, and Patrick Buthelezi, Economist at Sanlam Investments, the US Fed has a significant influence on emerging markets like South Africa.

“Historically, shifts in US interest rates have reverberated across global financial markets, affecting currencies and inflation expectations. The easing of US interest rates could provide a favourable backdrop for the SARB, facilitating a more accommodative monetary policy stance,” they said.

Because of this influence, the economists said that South Africans need to be patient when anticipating local moves on the interest rate. Moreso because local conditions – with core inflation still over 5% and outside the SARB’s target range – require the central bank to be vigilant.

“While the prospect of cutting interest rates later rather than sooner might initially evoke disappointment, it is crucial to adopt a long-term perspective,” the economists said.

“Patience and prudence in monetary policy decisions lay the foundation for sustainable economic recovery. As we navigate the path forward, a balanced approach that prioritises price stability as a contributory factor towards supporting economic activity will be paramount.”

The SARB’s monetary policy committee is likely to leave rates on hold on Wednesday’s meeting, with the market expecting a hawkish tone, given the higher levels of inflation and inflationary risks ahead.

If current projections prove true, the Sanlam Investments experts said South Africa faces a late start to the cutting cycle, which will likely be shallow and slow.

Read: Interest rates in South Africa this week – the best you can hope for

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