Sticky inflation lowers chances of interest rate cuts

Lingering uncertainty about when inflation will return to the central bank’s target midpoint and uncertainty about global disinflation contributed to recent market expectations that SA’s policy rate in 2024 may remain unchanged or near its 14-year high of 8.25%.

This is according to the Reserve Bank’s April monetary policy review published on Tuesday. In line with the most recent statement from the Bank’s monetary policy committee (MPC) in March, the publication casts doubt on whether headline inflation will move below 5% and closer towards the 4.5% midpoint of the 3%-6% target range this year.

The Bank expects headline inflation to moderate this year, averaging 5.1% — down from 6% in 2023 and 6.9% in 2022. But its return to the midpoint of the target band is expected only in the last quarter of 2025.

Borrowing costs have surged 475 basis points (bps) since November 2021. The repo rate was last adjusted in May 2023, when the Bank raised rates by 50 bps.

This has put pressure on indebted South Africans and the economy, which is struggling to show meaningful growth amid persistent load-shedding and logistical challenges at the country’s ports and railways.

According to the Bank, despite this “moderately restrictive” interest rate stance, headline inflation has remained above the target midpoint for 36 months running.

Earlier forecasts by the MPC suggested rate cuts could start in the first or second quarter.

However, the decision to delay proved prudent, the Bank said in the review.

“Had the MPC adjusted rates in line with the earlier, more benign, inflation forecasts ... inflation expectations could have worsened materially, delaying the path back to target and requiring higher rates again.”

Given that inflation showed signs of stickiness in January and February, some economists forecast that rate cuts would be delayed to September or later.

As previously reported by Business Day, Jee-A van der Linde, senior economist at Oxford Economics Africa, said that after last week’s publication of inflation data for March, which showed the consumer price index (CPI) eased to 5.3%, “the odds of the [Bank] delaying rate cuts this year are rising”.

According to the Bank, while forward rate agreement rates at the end of 2023 indicated that SA’s policy rate would be lowered in the first half of 2024, this picture has now shifted to reflect the slowing pace of domestic disinflation, implying that rate cuts would be deferred to early 2025.

“This contrasts with the surveyed expectations of analysts, which indicate two to three rate cuts in the second half of 2024.”

Setbacks

The Bank said that even though headline inflation had generally eased since 2022, there have been setbacks in food and fuel prices in recent months which pushed it closer to the upper limit of the target band.

“As inflation risks emerge and materialise, and services prices normalise, the path back to the target midpoint is expected to take time. The repurchase rate at 8.25% ... remains broadly consistent with persistent inflation, the uncertain domestic and global outlook, and getting back to the 4.5% midpoint over the forecast time frame,” it said.

Apart from some uncertainty in the outlook for food and fuel prices, administered prices for water and electricity continue to exert substantial upward pressure on headline inflation.

Core inflation, measured as headline inflation less food and energy, was still expected to average 4.8% this year — the same as in the previous year — before declining to the target midpoint in the final quarter of 2025. This is due to services inflation, which is forecast to rise from 4.2% last year to 5% this year and to remain elevated at 4.7% in 2025.

Other “obstacles to disinflation” were the weakness in SA government bonds and rand volatility, which indicated the continued concern about weak growth, fiscal sustainability and other domestic factors.

The Bank has long been keen on lowering SA’s inflation target to ensure the economy remains competitive. The Treasury hinted in the Macro-Economic Policy Review released as part of a package of budget documentation in February that it might be open to such a move.

Governor Lesetja Kganyago said on Tuesday there was “no virtue in high inflation”. He “couldn’t give a number” for what the new inflation target might be, but there was no policy basis for a higher target.

Competitiveness

“It can only go lower. Those countries that we generally compare ourselves with have narrower and lower targets. If we do not revise our target we will lose competitiveness,” Kganyago said.

Global inflation was expected to continue to moderate but to remain above major central banks’ targets in 2024, converging to targets from next year, the Bank said.

Recent commentary by the US Fed and the European Central Bank suggests that they will delay cutting interest rates due to higher inflation.

“Interest rate expectations have swung markedly over the review period, initially reflecting market exuberance about faster disinflation but recently becoming less sure of rate cuts amid signs of stickier inflation.

“Still, expectations are broadly for rate cuts to commence in major advanced economies in the second half of this year, but the magnitude of the expected monetary policy relief has been scaled back significantly,” it said.

Update: April 23 2024
This story has been updated with new information.

erasmusd@businesslive.co.za