Bad news for interest rates in South Africa coming this month

Increased uncertainty over rate cuts in the US and the probability of a VAT hike in the revised budget this week means that the Reserve Bank will likely skip an increase rate cut at its next meeting this month.

According to Investec chief economist Annabel Bishop, the South African Reserve Bank (SARB) is expected to be cautious when it announces its decision on 20 March.

At the last Monetary Policy Committee (MPC) meeting in January, the SARB cut interest rates by 25bps. However, this decision was not unanimous, as two committee members voted to keep rates unchanged. 

Given the growing uncertainty in global markets and domestic fiscal pressures, a follow-up cut in March appears increasingly unlikely. 

“Much will depend on the budget outcome this week,” said Bishop. “But the MPC has already indicated it was likely to pause at the March meeting, with its last statement indicating a growing uncertainty around its forecasts and a developing wait-and-see attitude,” she added. 

Bishop highlighted that the United States’ monetary policy stance is one key external factor influencing the SARB’s decision.

The Federal Reserve is also set to meet in the same week as the SARB, but financial markets overwhelmingly expect it to keep rates unchanged, with the first cut now projected for June. 

“The market ascribes a mere 4% chance of a 25-basis-point interest rate cut occurring this month in the US,” Bishop explained. “That probability rises to 43% by the May meeting, but a June cut is currently seen as almost certain.”

This delayed timeline presents a dilemma for the SARB. Cutting rates before the US does could put pressure on the rand, leading to currency weakness that would, in turn, drive inflation higher. 

“Rand weakness is negative for inflation,” Bishop warned. “If South Africa cuts rates ahead of the US, the currency could depreciate further, adding inflationary pressure when the SARB remains highly cautious.”

Compounding the SARB’s concerns is the likelihood of a VAT increase in the revised budget. 

The government is expected to announce a near 1% VAT hike, which would add approximately 0.5 percentage points to the year-on-year inflation outlook over the next twelve months. 

While this impact could be mitigated depending on the extent of additional zero-rating of consumer goods, Bishop said that a VAT increase “would add upward pressure to inflation,” making it harder for the SARB to justify rate cuts any time soon.

South Africa’s budget also faces higher borrowing risks, particularly if the government increases spending while limiting revenue-raising measures.

“A loosening in fiscal policy would make it more difficult for the SARB to deliver interest rate cuts this year,” Bishop said.

She explained that a more expansionary budget could drive up inflation expectations, forcing the SARB to remain hawkish.

However, despite these challenges, inflation in South Africa has been relatively subdued. The latest data for January showed consumer price inflation at 3.2% year-on-year, near the lower end of the SARB’s 3-6% target band.

February’s inflation reading, due next week, is expected to drop even closer to 3%, and projections suggest that inflation could remain below 3% until at least June.

“Such a modest inflation environment, absent a 2% hike in VAT, would support further interest rate cuts in South Africa,” Bishop said.

However, she noted that the SARB remains deeply concerned about the broader global economic outlook and the unpredictability of US monetary policy.

Beyond a potential VAT hike, Bishop warned that the government’s multi-year wage agreement with civil servants, which exceeds inflation, could contribute to sustained price pressures.

Given these factors, Bishop believes the SARB will err on the side of caution. “An increase in VAT, along with above-inflation wage agreements, will likely reinforce the SARB’s cautious stance, as it sees risks to the inflation outlook skewed to the upside.”

Looking ahead, Investec still expects the SARB to deliver two interest rate cuts in 2024—one in July and another in November, each by 25 basis points.