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Evaluating the Potential for SARB Rate Cuts Ahead of the Fed

There has been much discussion on the timing of upcoming rate cuts – both locally and globally. From the local perspective, popular opinion supports the view that the South African Reserve Bank will only move after the Fed moves. A few months ago, I was asked whether there was a chance that the SARB could cut rates before the Fed. I answered – perhaps a bit flippantly - that of course it was feasible that we could cut first. Maybe it’s a classic case of cognitive dissonance but now, with our elections finally behind us, I believe it would be of benefit to examine this in more detail. Why is there is a good chance we might just see the first rate cut at the 18 July MPC Meeting, and almost certainly by September? Still data dependent of course.

SARB Rate Cuts: Will South Africa Lead the Way?

At the most recent MPC meeting, Lesetja Kganyago, Governor of the SARB, appeared to be rather hawkish and reluctant to cut rates. He emphasised that surveyed inflation expectations remain higher than preferred by the Committee. He also noted that “there is still considerable uncertainty about the longer-run inflation outlook, globally,” and that locally conditions remained uncertain ahead of our elections.

Many market commentators have suggested that it is highly unlikely the SARB would begin cutting rates before the Fed. Sizeable interest rate differentials with respect to developed economies encourage portfolio capital inflows into Emerging Markets. As highlighted by the Organization for Economic Cooperation and Development in their recently published Economic Outlook, while easier global financial conditions could allow Emerging Markets to begin cutting rates, “a rapid narrowing of interest rate differentials could reignite capital outflows and currency depreciations".

Interest Rate Outlook: SARB vs. US Federal Reserve

However, it has happened in recent history that the SARB cut interest rates before the Fed. Following the Global Financial Crisis, economic growth in the USA averaged 2.3% per year from mid-2009 through 2019. This period of 128 consecutive months of growth in the US is the longest economic expansion on record. From December 2015 through December 2018 the Fed raised interest rates from 0.25% to 2.5%. They began cutting prior to the outbreak of Covid-19 as inflationary pressures eased in the middle of 2019. In July 2017 the SARB began to cut rates, even though the Fed was still only half-way through their hiking cycle.

South African Economy: Factors Supporting Early Rate Cuts 

In the SARB’s Press Statement they highlighted numerous factors that contributed to their willingness to cut rates. These included further deterioration in domestic growth prospects, a marked improvement in the Bank’s inflation forecasts and an improvement in surveyed inflation expectations. In truth, the SARB did only cut one more time in 2018 before hiking again at the end of that year, followed by the start of a new cutting cycle in line with the Fed in July 2019.

Global Rate Cuts: Central Banks Leading the Charge 

With inflation easing in most economies around the world, and each Central Bank assessing their own outlook somewhat independently, we expect to see a dislocation in rates cycles both in the pace and depth of potential easing. The ECB, and central banks in Switzerland, Sweden and Canada have already cut, with the UK expected to follow shortly. Locally, as we see the significant election / political risk premia begin to unwind, this could create the room needed for the SARB to begin cutting as well. Conditions are extremely like what they were in 2017, with low growth, high unemployment, struggling consumers and an inflation trajectory that does seem to be headed towards the targeted 4.5% mid-point. Now that the political uncertainty is out the way and inflation risks are relatively well balanced, a rate cut in July is now firmly back on the table. Similarly, the SARB’s Quarterly Projection Model also assumes that 100bps of rate cuts will commence in July in increments of 25bps.

Rand Exchange Rate: Sensitivity to Interest Rate Differentials 

Of course, the SARB will be at pains to emphasis that the MPC does not view monetary policy as the solution to the structural growth constraints in the economy. Nor does it believe that a reduction in interest rates will provide a significant stimulus to growth in the current environment of low confidence and political uncertainty. It will however provide some relief at the margin. Ultimately, future policy decisions will be dependent on data outcomes and the SARB’s assessment of the balance of risks. We remain hopeful that these conditions will now be met to open the door to the start of our easing cycle. And for consumers and investors alike, the relief will be palpable.

About the Author

Raphi Rootshtain
Senior Lead Portfolio Manager, Sasfin Wealth

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