Sanisha Packirisamy, Chief Economist at Momentum Investments Group

Highlights:

• Global central banks have increased the momentum behind interest rate cuts since the April 2024 Monetary Policy Review (MPR). Global and domestic conditions are conducive to a continued decline in inflation and lower interest rates. However, inflation risks persist, necessitating caution from central banks to prevent policy missteps.

• Due to central banks remaining cautious and the observation of a higher global r-star (the long-run real neutral interest rate) the South African Reserve Bank (SARB) flags that global interest rates will likely end 2025 at a higher rate than pre-pandemic levels.

• Domestically, inflation risks are assessed as being balanced. Upside risks include steeper electricity tariffs, higher wage growth and an increase in rental inflation. Downside risks include a significant strengthening of the rand. In the modelling done by the SARB, the emergence of the downside risk would bring inflation down by much more compared to the increase in inflation that could result from the upside risks materialising.

• Consequently, the downside risks would lead to a more accommodative monetary policy stance, while the upside risks would result in interest rates remaining restrictive for longer.

• Rental inflation is still viewed as an upside risk to inflation despite consistently surprising to the downside since the end of the COVID-19 pandemic. This is because the SARB considers landlords’ practice of maintaining low rental prices to boost vacancy rates as unsustainable. Furthermore, rental demand is expected to increase as economic growth recovers but supply is not expected to increase much over the near to medium term.

• Inflation expectations of businesses are better anchored in 2024 compared to the past two years but more still needs to be done.

• The United States (US) Federal Reserve (Fed) is expected to cut interest rates by a further 200 basis points by the end of 2025 with most emerging markets (EM), including SA, cutting interest rates by a smaller magnitude. This will encourage additional carry-trade flows, bolstering EM currencies.

• While SA’s risk premium remains high, the risk premium has narrowed over the past few months due to political stability and easing inflation. As a result, the SA yield curve has compressed since the April 2024 MPR.

• The two-pot retirement reform, effective from 1 September 2024, is estimated to support economic growth in the second half of 2024 and 2025 through higher household spending. This will result in a marginal uptick in inflation, which could necessitate a higher repo rate. The magnitude of the respective impacts depends on the amount of total withdrawals. The SARB’s estimated tax revenue impact is larger than the National Treasury’s estimate of R5 billion in fiscal year 2024/25 in both the high and moderate withdrawal scenarios.

• Shocks (COVID-19 pandemic, electricity load-shedding, logistical bottlenecks, July 2021 unrest and floods in KwaZulu-Natal in 2022) to the SA economy are assessed to have had a prolonged negative impact on economic growth. Getting back to what economic growth would have been in the absence of these shocks is possible but would be difficult. The economy would need to achieve an average annual growth rate of 3.2%, which is more than twice the currently projected average of 1.4%, by 2026.

You can read the full report here.

ENDS