Reserve Bank governor Lesetja Kganyago faced dissension in the ranks during the most recent meeting of the six-member monetary policy committee (MPC) he heads, with two members opposing the decision to hold interest rates for the seventh time.
Chris Holdsworth, an investment strategist at Investec Wealth & Investment, believes those in the minority made the right call. Now he reckons the country faces the threat of being tipped into a recession, a situation in which the economy contracts for two consecutive quarters.
“It was a risky move given the improved inflation trajectory,” Holdsworth said in his weekly podcast.
The reason? The central bank’s own forecasts predict inflation will fall below the 4.5% midpoint target by the fourth quarter of this year and remain there for three quarters. If this is accurate, and the MPC cuts rates three to four times by 25 basis points (bp) over the next year, the gap between inflation and interest rates will still be the widest in 19 years.
What this means is that monetary policy will become even tighter, an approach that is typically used to slow an overheated economy to restrict spending and contain inflation. The central bank’s benchmark lending rate is currently at 8.25%, a 15-year high, while inflation in May stood at a four-month low of 5.2%.
“This is the sort of scale that could put South Africa into recession or at least slow growth materially, at which point the MPC is likely to get some tough questions,” Holdsworth said. “There could be damage to the central bank’s credibility given unnecessarily tight monetary policy. It is not clear what threat to inflation the MPC sees to justify taking these risks.”
Investec Wealth & Investment expects inflation to be below 4% by October. The delay in reducing rates at the MPC’s July meeting may mean “that they’re going to have cut by more later on”, Holdsworth said.
Ninety One investment director Vivienne Taberer believes the MPC is likely to cut rates by 25bp at its next meeting on September 19.
In the wake of the recent rate decision, the market is now pricing in a cycle of slightly less than 100bp over the next 15 months, she said.
“Our analysis of over 70 global interest rate cycles over the past 20-plus years has taught us two things: first, markets generally underestimate hiking cycles; and, second, they underestimate the speed and magnitude of the cutting cycle. We do not expect the South African cutting cycle to buck this trend.”
A shift towards lower interest rates is being helped by a stronger rand, relatively stable oil prices and the European Central Bank’s 25bp cut in June. The US Federal Reserve is also able to move toward its first cut in September as the world’s largest economy cools.
Between November 2021 and May 2023, the MPC implemented 11 interest rate hikes, totalling 475bp, placing immense financial strain on South African consumers. The economy contracted by 0.1% in the first quarter of this year, compared with the previous three months, surprising economists who had expected the GDP to expand by 0.1%.
Any recession may be short-lived, though.
For Johann Els, the chief economist at Old Mutual Group, it is crucial that rates be cut to provide “relief to the economy” and drive “positive economic momentum” by stimulating spending and alleviating consumer stress. He also takes a longer view, expecting medium-term economic growth to increase to about 2.5% after averaging 1% before Covid.
However, while political uncertainly in South Africa has subsided with the formation of the government of national unity and an improvement in the country’s energy constraints, policy implementation risks will weigh on the Reserve Bank’s mind, according to FNB chief economist Mamello Matikinca-Ngwenya. It doesn’t help that inflation surveys show that people believe inflation will hold above 4.5% either, she said.
FNB expects the Reserve Bank to remain cautious and that it will proceed with a “shallow cutting cycle”. For consumers, that means accessing savings will not be as affordable as it was in the years leading up to Covid, Matikinca-Ngwenya said.
Even so, the lender sees the economy gathering pace into the second half of 2024, with inflation and interest rates not the sole drivers of growth.
“We have already seen a clear improvement in business conditions and employment opportunities across many sectors of the economy with encouraging signs of a recovery in overall GDP,” said Matikinca-Ngwenya.