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NOW ep82: As central bankers worldwide shift towards easing monetary policies, what kind of rate-cutting cycle are we entering? In the latest episode of No Ordinary Wednesday, Investec Treasury Economist Tertia Jacobs shares her expert insights on the factors that will the trajectory of interest rates in the coming months.
Several constructive developments post the May general election have combined to return inflation to the mid-point target of 4.5% earlier than the SARB’s projections, as well as on a sustainable basis. The latter has been the SARB Governor’s key requirement for rate cuts to commence.
Key focus points
The upcoming September meeting will unveil the South African Reserve Bank (SARB)’s updated inflation forecast, which is expected to be revised downwards.
The Quarterly Projection Model’s (QPM) rate forecast may be influenced by potential adjustments to the risk premium. The medium-term inflation trajectory could be kept at 4.5%.
If lowered, the risk to the forecast will remain to the upside. Currently, the real policy rate appears wide by all measurements, including an improvement in the BER’s Q3 inflation expectations survey, except for Latin American real policy rates.
At the press conference, the Governor of the SARB is most likely to stick to the data dependency on future decisions in the context of the balance of risk assessment.
Finally, the FOMC’s decision the previous night, with a case for a 25bps or 50bps rate cut and market-implied rates pricing in a 47% probability of a 50bp rate cut, could have a bearing on the MPC’s decision.
Forecast: Investec for Corporates & Institutions expects a 25bps rate cut in a unanimous vote if the FOMC cuts its policy rate by 25bps, with a 40% probability of 50bps if the FOMC delivers a jumbo cut.
Macro forecasts:
Inflation down/GDP slightly higher
What has changed since the July MPC meeting for the inflation projection:
- Currency risk associated with prolonged higher US interest rates has diminished as the FOMC begins to cut rates. This shift will enable EM central banks to lower real rates, which have been restrictive to safeguard their currencies against the impact of US rates staying higher for longer.
- Bloomberg’s global inflation rate has moderated to 4.6% from 5.3% in July, with China’s muted inflation rate of 0.5%, a concern.
- The R/$ has consolidated in a trading range of R18.0/$ to R17.72/$ since mid-August but is ~5.6% firmer than levels prior to the May election. The pass-through effect of this magnitude is ~0.5ppt. The starting point of the R/$ forecast in the SARB’s inflation forecast could be revised from R18.335/$ to ~R18.10/$ (with the current three month rolling average at R18.22/$). ICIB’s calculation of core goods inflation, which are sensitive to the exchange rate, has receded to 3.2% in July.
- The direct effect of the stronger rand, together with a decline in the oil price to $72/bbl, has been evident in a significant reduction in the fuel price, totalling R3.36/l from May to September. Another cut of at least ~R1.20/cl looks likely in October.
- Food price inflation has been subdued, moderating to 3.9% in July.
- The starting point of the inflation forecast is lower, owing to July’s CPI inflation of 4.6% beating forecasts of 4.8%.
ICIB forecasts inflation to average 4.4% (SARB: 4.8%) in Q3 24 and 3.5% (SARB 4.3%) in Q4 24. In H1 2025, inflation could remain below 4.0% (ICIB 3.8%; SARB 4.2%).
The forecast for H2 25, however, faces upside risk due to Eskom’s request for an electricity tariff increase of 36% compared to the SARB’s assumption of 10.9% and an increase of 12.7% in 2024.
While Nersa is unlikely to grant Eskom’s request, the risk of administered price inflation again frustrating inflation settling at the mid-point of the target, is high.
GDP growth projection
The SARB’s GDP growth forecast of 1.1% for 2024 may be revised slightly upwards if the assumption of 180 days of loadshedding is lowered, as this currently detracts 0.2ppt from GDP growth.
The 2025 forecast of 1.5% could also see slight adjustment. However, a significant revision driven by the much-anticipated accelerated implementation of structural reforms that could raise GDP growth to 2.0% is unlikely to be incorporated into the baseline forecast.
Pace of rate cuts in coming months
The SARB communication at the press conference will be important in shaping expectations of the pace and magnitude of rate cuts in coming months. ICIB’s baseline forecast is for the MPC to be gradualistic compared to a more front-loaded profile, even as a highly restrictive real policy rate allows for a 50bps cut. The FRA curve’s rate expectations pricing shows 150bps cuts in 12 months.
The front-end of the curve out to mid-December 2025, which covers two MPC meetings, has priced in 70bps of rate cuts. This shows one of the meetings, possibly in November, is skewed to a 50bps rate cut. ICIB’s baseline forecast has been for 25bps at each of the four upcoming MPC meetings. However, we attached a 40% probability to a 50bps rate cut at either the September or November MPC meetings, which could see a total of 125bps by May 2025.
Developments that could shape rate expectations in the context of the lower projected inflation forecast:
- In the US, the FOMC’s decision on September 18 will be crucial, particularly in conjunction with the dot plot forecast. There is likely to be ongoing debate regarding the pace of rate cuts – whether they will be implemented gradually or in a more aggressive, front-loaded manner, as well as the end-point of the cycle, as the FOMC remains data dependent. The dots for end 2025 and end-2026 could possibly show there is a wide dispersion. There is volatility risk associated with a possible repricing of implied rate expectations, with implied rates discounting 115bps of rate cuts by December 2024.
- The MPC’s balance of risk assessment in the context of a possible lower QPM terminal rate (currently 7.29% and 7.25% in Q4 25 and Q4 26) and a real neutral rate of 2.7%. The MPC will look through the meaningful deceleration of inflation in Q4 24 emanating from the sharp decline in the fuel price, which will show up in elevated current real policy rates. This could shape the debate about a gradual/front loaded rate cut debate, but the needle for the terminal rate could possibly decline by 25bps or so to 7.0%.
