/ 28 May 2024

Explainer: How the Reserve Bank decides on interest rates

South African Reserve Bank Governor Lesetja Kganyago Interview
Reserve Bank governor Lesetja Kganyago. (Waldo Swiegers/Bloomberg via Getty Images)

The South African Reserve Bank’s monetary policy committee (MPC) will meet this week to decide on the country’s interest rate. 

Economists forecast that the Reserve Bank will hold the interest rate at 8.25%, but that it will cut it later this year, subject to headline inflation, which, according to Nedbank, is slated to ease to 4.8% by the end of the year. 

April’s consumer inflation retreated slightly to 5.2% year-on-year after sliding to 5.3% in March from 5.6% in February. But this is probably not enough to convince the Reserve Bank to cut borrowing costs.  

“The bar for a rate cut has not been cleared yet,” Nedbank chief economist Nicky Weimar said in a MPC preview last week. 

“Two months of inflation relief do not constitute a trend. The MPC would likely prefer more compelling evidence of consistent disinflation before shifting its stance.”

Although movement in consumer inflation is significant for setting the interest rate, there are other global economic movements that factor into the decision. 

One of the key players is the US Federal Reserve. 

The US dominates the world economy and the Fed serves as a reference point to the world’s central banks.  

The Fed has a dual mandate: to achieve price stability and maximum employment. It targets a 2% inflation rate to achieve this mandate.

The South African Reserve Bank also targets inflation to achieve price stability. But, given their effect on the currency — and inflation — the Reserve Bank also closely follows the Fed’s policy decisions.

“If you look at where the economy is in terms of growth, it would be nice if the Reserve Bank cut interest rates. That would help our economic growth,” said Stanlib chief economist Kevin Lings.

“Inflation is inside the target. It’s not massively inside the target, but it’s inside the target. And you could make an argument to start to cut South African interest rates. The problem is that the United States is not cutting interest rates. And … we run the risk that as we cut interest rates, the rand starts to weaken more.”

US inflation moderated to 3.4% year-on-year in April, from 3.5% in March — bringing the rate closer towards the Fed’s target. This, Lings said, will raise expectations of an interest rate cut in the US later this year.

But US Fed chair Jerome Powell noted on 14 May that although inflation outcomes were higher than anyone expected and the US economy was performing relatively well, “the policy rate is currently restrictive by many measures and that the Fed needs to be ‘patient and let restrictive policy do its work”.

The Reserve Bank does not have to wait for the Fed to cut interest rates. But it would probably want a high level of confidence that the Fed is going to cut interest rates quite soon, Lings said. 

Despite South Africa’s headline inflation rate being within the Reserve Bank’s 3% to 6% target range, Weimar pointed out that sticky global inflation and higher-for-longer US interest rates are seen as upside risks to the domestic inflation outlook. 

“These upside risks will probably remain in place until the global disinflationary process gathers renewed traction and the US Fed begins to ease its monetary policy,” she added.

“A key implication is that emerging market currencies could be vulnerable if their central banks opt to cut interest rates before the US.”

Nedbank forecasts a cut as early as September this year, and another in November, which will take the repo rate to 7.75% and the prime lending rate at 11.25% by the end of 2024. 

“We don’t think the US is about to cut. We don’t think South Africa is about to cut interest rates. But are we slightly closer to that point after last week’s data? Yep, we probably are. That gives us some confidence,” Lings said.