The South African Reserve Bank (Sarb) has raised the repo rate from 7.00% to 8.25% through 2023, the highest level in 14 years. At the first Monetary Policy Committee (MPC) meeting of 2024, Sarbu Governor Lesetya Kganyago broadly echoed the general sentiment about serious upside risks to inflation, with the committee unanimously voting to keep the repo rate unchanged. It was unanimously resolved.
Read: Sarb keeps repo rate stable at 8.25%
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While there are certainly a wide range of inflation risk factors influencing the MPC's outlook, they appear subdued compared to those that have weighed on the domestic and global economies over the past two years. While it is prudent to expect a rate cut cycle to begin soon, it is likely to be a short and shallow cycle given the robust offshore labor market and US consumer demand, as well as structural constraints within the SA economy that are pushing up price levels. be.
Why does Kuganyago wake up at night?
Kganyago's main concerns are high and unpredictable local food prices, as seen in the egg market after the bird flu outbreak, and delays in vaccinating local chickens. Food inflation is notoriously difficult to predict, but we think the upside risk is much lower than in 2022 or 2023. In addition to significantly reducing its price base, SA has also divested itself of many risks. -The El Niño weather cycle has remained intact so far, with a high yield of yellow corn predicted.
Kganyago also remains concerned about the inflationary impact of load restrictions and logistical constraints at South Africa's ports and along Transnet's rail network. These constraints are likely to continue to drive up local production costs, but it should be noted that the damage should be less than that experienced during the peak of Stage 6 load reduction in 2023. That's it. Transnet's management changes also embrace private sector involvement to solve the logistics crisis.
Read: Transnet's personnel changes pay off
When looking at offshore inflation trends, Kganyago's concerns primarily relate to the strong U.S. labor market and high wage growth, which will create a secondary inflationary effect through robust consumer demand for services and goods. there is a possibility. The only problem with the U.S. labor market is that there is nothing wrong with the labor market, as the unemployment rate remains near its lowest level in decades.
Geopolitical tensions such as the Red Sea attacks are also extending global shipping times, albeit on a much smaller scale than the 2022 we are used to. Still, a third of the world's container shipping passes through the Suez Canal, and routes are being rerouted. Trade through the tip of Africa certainly puts the “just-in-time” delivery model at risk. This could pose a temporary upside risk to inflation expectations if the supply of finished goods declines or prices rise.
Read: Maersk sails south of Africa to avoid Red Sea disputed areas
Major U.S. automakers have already announced they will suspend production capacity through February because of these delays, and some are resorting to much more expensive air transport.
A huge burden on the serve
Several Sarb members have advised that SA rates' high interest rate was not an ideal outcome, but was necessary as the bank is carrying a heavy burden in terms of stabilizing South Africa's macroeconomy and inflation.
In this regard, the Salve party has repeatedly called on the government to share the burden through prudent fiscal policy. In reality, Sarb would like to see lower interest rates and lower inflation, but achieving this is difficult as the government continues to maintain imprudently high debt levels and the country's risk premium is rising. has not been completed. This country risk premium comes as foreign investors demand higher interest rates to invest in a growing number of South African government bonds and refinance the debt of ailing state-owned enterprises such as Eskom and Transnet. The rise is entrenched in the country's borrowing costs.
This country risk premium also contributes to a depreciation of the rand exchange rate and, as a result, an increase in import price inflation.
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Saab not only aggressively reduces the debt mountain, but also urges the government to reduce inflation by increasing energy supplies and limiting real government wage growth, commensurate with our economy's weak economic productivity growth. Continues to recommend.
Read: Locking in high interest rates: The story of inflation
Saab's final problem is that administrative prices for electricity, water, fees and taxes have been allowed to rise by double digits, faster than the country's target price inflation. Such price pressures reduce consumers' appetite for borrowing, a necessary evil that crushes household demand, forcing Sarb to keep interest rates higher than it would like. In theory, such measures are aimed at preventing secondary price increases from taking hold.
future of interest rates
That said, the market is pricing in Sarb to begin cutting rates in mid-2024, in line with Sarb's quarterly forecast model. Although the model is just a policy proposal, it would end in a short and shallow rate-cutting cycle, with the repo rate falling from 8.25% to 7.3% by the end of 2025, still 100 basis points above pre-COVID-19 levels. .
Video: Interest rates in 2024 – what to expect?
Interest rate caps are considered much more necessary than in the past, given the Salve government's mandate to maintain price stability in the economy and Prime Minister Kganyago's expectations that global inflation will remain higher.
only time will tell.
Talia Petousis is a portfolio manager for the Alan Gray Money Market Fund.
