Will lower inflation mean lower interest rates?

After the inflation rate dropped again to an unexpected 4.7%, consumers are wondering if that will mean lower interest rates, but economists say the South African Reserve Bank (SARB) will first want clear evidence that inflation has sustainably reverted to the midpoint before loosening monetary policy.

The Monetary Policy Committee (MPC) of the SARB meets every second month to determine the repo rate and influence the level of inflation.

National Treasury sets the inflation target in cooperation with the SARB. Inflation targeting aims to maintain consumer price inflation between 3% and 6%.

Economic research group, Oxford Economics Africa, says the country’s inflation is now gravitating towards the midpoint.

“Headline inflation is cooling rapidly but it has primarily been due to favourable base effects, most of which have now run their course. South Africa’s inflation rate is expected to oscillate above the midpoint of the inflation target band over the coming months.”

The inflation outcome was lower than Oxford Economics Africa’s estimate and the consensus forecast of 5.0%. The July inflation print is the lowest since July 2021, when the rate was 4.6%.

“Favourable base effects have proven effective in driving down the headline inflation rate, which peaked at 7.8% in July 2022. Our revised forecast sees inflation averaging 5.8% in 2023. Going forward prices will get stickier, and a series of domestic fuel price increases could keep the inflation rate too high for the SARB’s liking.”

However, the group says, the favourable inflation surprise in July increases its subjective odds of the SARB bringing forward interest rate decreases from the current baseline which sees rate cuts somewhere mid-2024.

“As things stand, we do not think it likely that the SARB will cut rates ahead of the US Fed, which should start to slash rates in the first quarter of 2024. Higher for longer rates seems to be the new concern with key monetary authorities likely to debate the issue at the Jackson Hole Symposium this week.

“We expect the SARB will stay put during its next monetary policy committee meeting in September, amid lower headline inflation. Using the July CPI inflation rate, South Africa’s real repo rate is calculated at roughly 3.6%, the highest since April 2006.”

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Inflation now comfortably within target range

Reza Hendrickse, portfolio manager at PPS Investments, says inflation peaked at 7.8% in July last year and is now comfortably back inside the SARB’s 3-6% target range.

“Food and non-alcoholic beverages, housing and utilities and miscellaneous goods and services were the main categories contributing to year-on-year inflation, which is expected to now remain within the SARB’s target band.

“External price pressures have eased somewhat but local factors such as the price of electricity, as well as the weaker rand, should continue to exert upward pressure.”

She says the steady pace of disinflation in South Africa is consistent with the global trend and this is partly explained by base effects given last year’s very high base, but also through the easing of supply chain bottlenecks globally and lower commodity prices, particularly energy.

“However, central banks, including the SARB, have maintained tight monetary policy settings. The US Fed hiked rates in July after a pause in June, which gave the SARB leeway to also keep rates unchanged in July. The SARB would be justified in once again keeping rates unchanged at the September meeting, given this month’s inflation print.”

The Nedbank Group Economic Unit says the July inflation outcomes are encouraging.

“We expect inflation to remain below 6% for the remainder of the year, averaging 5.8% for 2023. The downward trend will continue to come from fuel and food prices. The weaker global economy will contain the price of Brent crude oil, which will translate into lower fuel prices.

“Food prices are also expected to fall further off a higher base, as the lagged effect of the drop in global prices continues to filter through the economy. However, there are upside risks to food inflation, emanating from higher domestic production costs, including the cost of sourcing electricity from diesel generators given persistent load-shedding, as well as a vulnerable rand.”

The group says lower inflation will probably prompt the SARB to maintain steady interest rates for the remainder of 2023, with the first cut in the first quarter of 2024 and the repo rate falling to 7.25% in November 2024.

“The latest inflation figure greatly reduces the likelihood of another SARB hike, even if the Fed hikes further in September.”

ALSO READ: Repo rate unchanged thanks to inflation moderating

Promising outlook

Prof Raymond Parsons, economist at the North-West University’s business school, says the omens for the inflation outlook in South Africa look promising. “It is likely that the declining trend in the rate of inflation will continue for the rest of the year, with inflation remaining well within the SARB’s 3-6% inflation target range.

“While the falling rate of inflation is positive, upside risks to the inflation outlook still exist, including the vulnerable rand and administered prices such as Eskom tariffs.”

He says the better news on the inflation front is encouraging for consumer and business confidence. “There is a sufficiently persistent trend of improvement in the inflation outlook to justify the Monetary Policy Committee again leaving interest rates unchanged at its meeting next month.”