Interest Rate Outlook: slow and steady, more cuts next year

The South African Reserve Bank’s latest monetary policy communication shows a slow and steady approach, only cutting the repo rate by -25bp this month, despite CPI inflation now below the 3-6% range at 2.8% y/y, and well below the 4.5% target point.

This is due to inflation targeting having a forward-looking approach instead, targeting future inflation twelve to eighteen months out specifically, with the next six to twenty-four months also important. The MPC has been wary in the face of its identified risks. 

The SARB’s latest forecasts show CPI inflation is expected to average 4.0% y/y next year, and 3.2% y/y in Q4.24, with Q1.25 averaging 3.5% y/y and Q2.25 at 3.7% y/y - all forecasts made by the Reserve Bank and updated recently lower. 

With the inflation outlook in the longer-term around the 4.5% y/y midpoint of the target however, from Q4.25 to end 2025 and over 2026 (the inflation target period), the SARB has a reason to be cautious in its interest rate cutting cycle.

That is, the SARB’s (South African Reserve Bank) inflation forecast runs at the inflation target, of 4.5% y/y over the period it targets, on the basis of around two more -25bp interest rate cuts next year, and a further one (-25bp) in 2027. 

This therefore totals a further -75bp worth of cuts in South Africa’s current interest rate cycle, spaced out over 2025 and 2026 to balance the inflation rate at the target point of 4.5% y/y over the (forward looking) period that the MPC targets.  

The Reserve Banks’s  Monetary Policy Committee’s (MPC’s) forecasts also included the effect of the -25bp cut in Q4.24 which occurred yesterday in the outlook for inflation, with the MPC’s envisaged rate cutting cycle not one which is rushed.

Furthermore, the Reserve Bank noted at its MPC meeting that the risks to this outlook are balanced, but also that it reassesses the risks at each MPC meeting, and consequently adjusts the outlook, and so figures, if necessary. 

Key is that it is not past readings of CPI inflation that matter to the inflation targeting process, but instead forward readings in the target period, and with these at the midpoint of the target and risks apparent, the MPC is consequently cautious.

Consequently, the SARB has a number of different scenarios to its central forecasts on inflation and interest rates, and notes that “the risk outlook, however, requires a cautious approach”.

In its first scenario, the MPC worries that “global interest rates could well shift higher again, and the recent rand depreciation demonstrates how rapidly changes in the global environment can affect South Africa.”

In particular, “there are scenarios where inflation is higher than in our baseline. During the meeting, the MPC explored two such risk cases.  One assumed higher administered price inflation.”

“The other envisioned a more difficult external environment, with a weaker rand and higher oil prices. We also considered a favourable scenario where geopolitical tensions subside and the oil price falls.”

“These scenarios underscored the uncertainty surrounding the outlook. Given a challenging external environment”. With apparent risks of a further escalation in geo-political tensions and a change in regime in the US, the outlook is uncertain. 

In addition, risks to the inflation outlook include those in SA, with changing weather conditions impacting the largest single component of the CPI inflation basket, food prices, while exchange rate moves can have a considerable impact on commodity prices.

For commodities’ prices themselves, a disruption in oil supply is feared on an escalation in the Middle East conflict, or a marked intensification in the Russian Ukraine war. Higher oil prices feed directly through into higher inflation for SA.

Similarly, for grain prices, blockages to exports early in the Russian-Ukraine war pushed up international agricultural food prices substantially, causing higher inflation in SA, as SA is an import parity exporter/importer.

In particular, “the MPC would like to emphasise that its decisions will be made on a meeting-by-meeting basis”,  with “no pre-commitment to any specific (interest) rate path”, with a possible shallower or deeper interest rate cut cycle if risks devolve.