Reserve Bank governor Lesetja Kganyago was in a confident mood after last week’s monetary policy committee (MPC) meeting, declaring that the Bank’s policy stance had been vindicated and that, after the worst inflation surge in a generation, a soft landing was looking more likely.
The improvement in domestic inflation, from an annual high of 6.9% in 2022 to a three-year low of 4.4% in August, has not, however, been painless. Interest rates were raised to 15-year highs, many consumers were pushed into debt distress and the economy came within a whisker of a recession in the first half of the year.
But over the past few months, the fading of the energy crisis and the formation of the government of national unity (GNU) have lowered political risk, improved the country’s fundamentals and helped to buoy the rand.
All this has hastened the decline in inflation and allowed for a dramatic improvement in the Bank’s inflation forecast. Inflation fell below 4.5% in the third quarter, a quarter earlier than the Bank expected in July, and three quarters earlier than it predicted in May.
Both headline and core CPI are now set to remain below the 4.5% midpoint of the target range for all of 2025 and 2026, given expectations of a stronger rand, lower fuel inflation and better-behaved food prices.
As long as headline inflation stabilises at lower levels, the Bank expects to make further progress in re-anchoring inflation expectations around the middle of the target range. Though expectations have been slow and sticky to unwind, they are finally moving in the right direction.
This cleared the way for the MPC to begin its rate-cutting cycle last week. Its decision to cut the repo rate by 25 basis points (bp) to 8% was unanimous.
Kganyago said the country’s improving inflation trajectory showed that “while there are a lot of moving parts, what cannot be taken away is that the policy stance was the right one”.
The consensus is that the decline in inflation will be sustained, allowing the Bank to keep cutting in 25bp increments at each of the next three MPC meetings.
This will take the terminal repo rate down to 7.25% by March next year, in line with the Bank’s forecast, which has the repo rate “stabilising slightly above 7%” — its estimate of the neutral rate (where monetary policy is neither accommodative nor restrictive).
The Bank assesses the risks to the inflation outlook to be “balanced” in that actual inflation could turn out either better or worse than it’s expecting. But while several economists believe that inflation will come in even lower than the Bank expects, Kganyago is not ready to declare victory.
“Overall, global conditions have become more favourable, but there are still risks,” he said during the post-MPC briefing. “A soft landing is looking more likely, after the worst inflation surge in a generation, but it is not inevitable.”
He emphasised that while global inflation is slowing and nearing targets, global central banks “are approaching the endgame with caution”, given the “difficult and unpredictable” geopolitical environment and risks of new inflationary shocks through trade restrictions and supply chain disruptions.
“Both trade restrictions and debt levels are rising and might go much higher,” he said. “This mix could add significant inflationary pressure to the world economy, generating tighter financial conditions for South Africa and other countries.”
The main domestic risks that could upend the Bank’s benign inflation forecast include unpredictable food inflation, higher housing costs, larger electricity price increases, or wage increases that outrun inflation and productivity growth.
David Omojomolo, Africa economist for London-based Capital Economics, says the Bank’s hawkish tone may, once again, be “overcooked”. He expects South Africa to experience low inflation and sluggish growth in the near term and for the repo rate to be lowered all the way to 6.25% by the end of next year, which is significantly below the consensus.
The Bank concedes that inflation could just as easily undershoot its forecast than overshoot it, especially if oil prices are lower or the exchange rate appreciates further than it expects.
Financial markets are bullish. Indicative market pricing has the repo falling to 6.75% by the end of 2025. This suggests either that the markets expect inflation to fall off a cliff, or that the Bank will convince the National Treasury to lower the inflation target to 3% during the course of next year. (This would lower the neutral rate from about 7% to about 5.5%, creating more room for rate cuts.)
The best time to lower the target is when CPI is collapsing, the US Federal Reserve is cutting and the rand is strong. So, if the target is going to be lowered in keeping with South Africa’s emerging-market peer group, now would be the time to do it. After all, Kganyago has been talking about doing so since 2021.
But neither finance minister Enoch Godongwana nor the DA is in any rush to lower the target before energy and other administrative prices have been properly reined in. Eskom tariffs in particular pose upside risks to the inflation outlook, given that it is seeking price increases of 36%, 12% and 9% in the next three years.
There is pressure from the electricity ministry, parliament, the presidential climate commission, GNU partners and other key stakeholders for electricity pricing reform to cushion the economy before any final pricing decisions are taken.
Challenged during the MPC press conference on whether the Bank was “behind the curve” or too cautious, Kganyago replied: “You’ve got to be cautious; adventurism is not part of our monetary policy toolkit.”
In the end the Bank’s future decisions will remain highly data dependent.
While conceding that the Bank’s model shows another 25bp in November, Kganyago reiterated that the Bank does not follow the model mechanically. If it did, it wouldn’t need the MPC, he said, noting that its members are “vigorous debaters”.
“At the beginning of the meeting you’ll ask whether these chaps will ever reach a decision,” he said. “The one thing about them is that they understand data … To arrive at a decision we beat the data until it confesses. And so, we are data dependent in our decision-making.”
Still, South Africans will look with envy at the Fed’s decision last week to jump-start its easing cycle with a 50bp cut. Moreover, the Fed looks set to cut by a further 50bp by the end of the year and by another 100bp by the end of 2025.
A key difference between South Africa and the US, however, is that the Fed has ample policy space — rates are still almost 200bp above the neutral rate of about 2.9%.
While Fed chair Jerome Powell has emphasised that the risks are balanced between the Fed’s dual mandate of stable prices and full employment, the Economist Intelligence Unit believes the jobs outlook is “driving the bus” in the magnitude and pace of cuts.
This is because whereas the outlook for inflation has improved slightly since March, the outlook for unemployment has slipped. The Fed is keen to ensure the labour market does not deteriorate beyond its current projections.
“Of course, the Fed must be monitored closely,” says Citi economist Gina Schoeman. But she points out that the Bank doesn’t follow the Fed’s timing or the magnitude of its cuts, given the numerous differences between what drives inflation and growth in the two countries.
In Citi’s view, the Fed cut by an outsized 50bp partly because it should have cut earlier, in July, and so had to play catch-up.
“If US data deteriorates more than expected, the Fed could continue with 50bp cuts or resort to larger cuts,” says Schoeman. “But that would start to signal some form of panic, and we’d have to assess if the economic weakness was spilling into South Africa via capital flows and growth.”
If that doesn’t happen, the Bank should be able to stick comfortably to 25bp increments, Schoeman says, especially as South Africa’s growth underpinnings have improved structurally over the past year with the cessation of load-shedding.
Last week, the Bank pared back its estimate of the effect of load-shedding on future GDP growth from -1.5 percentage points (pp) in 2023 to -0.13pp for 2024 (previously -0.18pp), and zero for 2025 and 2026 (previously -0.05pp and zero).
Over the medium term, it expects growth to be bolstered by better-functioning network industries and an acceleration in other structural reforms. But it’s still reluctant to revise its growth forecasts above 2% in the absence of a fixed investment upswing.
The Bank’s 2024 GDP forecast remains unchanged at 1.1% while estimates for 2025 and 2026 were nudged only slightly higher to 1.6% (from 1.5%) and 1.8% (from 1.7). As with inflation, it sees the risks to the growth outlook to be balanced.