A look at South Africa’s recent history would suggest that the monetary easing cycle has further to run. We now expect an additional 75bp of cuts in the coming months, taking the repo rate from the current 3.75% to 3.00% by year-end. This is more loosening than financial markets are currently pricing in.
- A look at South Africa’s recent history would suggest that the monetary easing cycle has further to run. We now expect an additional 75bp of cuts in the coming months, taking the repo rate from the current 3.75% to 3.00% by year-end. This is more loosening than financial markets are currently pricing in.
- The South African Reserve Bank (SARB) has lowered the repo rate by a cumulative 250bp since March, from 6.25% to the current level of 3.75%. With the repo rate at the lowest level since its introduction in 1998, it begs the question just how low can interest rates go? Financial markets offer one answer. Based on forward rate agreements, investors seem to be pricing in just one more 25bp rate cut, to 3.50%, in July.
- From an economic perspective, one approach is to use Taylor Rules – that is, to model the path for the policy rate based on its past relationship with macroeconomic variables. The SARB’s own Quarterly Projection Model (QPM) is one such model and has an impressive historical fit with the policy rate. (For more details, see here.) Based on the SARB’s inflation and GDP projections (which look reasonable to us), the QPM indicates two additional 25bp cuts, to 3.25%, this year.
- But while the QPM models historic rate decisions fairly well, the SARB frequently cautions against following it as a strict guide to monetary policy. We think this is especially true now, as the QPM’s large weight on the previous repo rate (as an anchor to reduce volatility) doesn’t seem appropriate at a time of a huge external economic shock. Policymakers appear to be more focused on supporting the economy.
- History can offer another set of answers by comparing the degree of monetary stimulus provided to date to its previous levels. To do so we should look at the level of the real interest rate (the policy rate less inflation over the following 12 months). In 2013, the real interest rate fell considerably into negative territory, hitting a trough of -1.1% compared with -0.1% now. (See Chart 1.)
- But to consider the degree of monetary stimulus, we also need to compare the real interest rate with the ‘neutral rate’, or r* – that is, the real interest rate at which the economy would grow in line with its potential, sustain full employment and keep inflation at target. Research by the SARB suggests that r* has declined by 75-100bp since 2013. This implies that, for monetary policy to provide the same degree of stimulus as it did in 2013, the repo could be lowered by an additional 175-200bp, to 1.75%-2.00%.
- The final thing to consider is risks around the currency, which could deter policymakers from providing much more monetary stimulus. The differential between (nominal) policy rates in South Africa and the United States has been smaller in the past than it is now – in 2006, it fell to 175bp, compared with the current level of 325-350bp. But that was a time of rapid capital flows to emerging markets.
- Another approach is to look at how real interest rates in South Africa compare with other EMs, to gauge the attractiveness of local assets. Viewed this way, the scope for easing looks more limited. (See Chart 2.) Further rate cuts would make real rates in South Africa look relatively low.
- Taken together, past precedent suggests that the SARB could do much more to support the economy although currency risks will probably prevent policymakers from taking real rates quite that low. We now think that the repo rate will end this year at 3.00%, after 75bp of additional cuts over the coming months.
Chart 1: South Africa Real Interest Rate* (%)
Chart 2: Real Interest Rates* (%, Latest)
Sources: Refinitiv, Capital Economic
Sources: Refinitiv, Capital Economics
Virág Fórizs, Africa Economist, firstname.lastname@example.org