Introduction

At the time, the annual inflation rate was a very modest 2.3%, but it had averaged 7.3% over the preceding five years, spiking to over 10% at times. This suggested that achieving the inflation target was not going to be easy, and would require a meaningful change in policy implementation.

Fortunately, since February 2000, SA’s inflation rate has averaged 5.6%. It has been at or inside the inflation target range for almost 75% of the time over the past 15 years. This is a heartening and important economic success story, especially given SA’s general economic malaise since 2010.

Keeping the inflation rate persistently inside the target range is challenging for a variety of reasons. These include the volatile and relatively weak rand exchange rate; above-inflation wage increases in key economic sectors, including the public sector; poor productivity growth in most industries; sustained large increases in key administered prices (for example the cost of water and electricity); and a rise in import intensity.

Recent inflation success supports lower interest rates

In recent years, the South African Reserve Bank (SARB) has been consistent in highlighting its desire to get SA’s inflation target anchored around the midpoint of the inflation target (4.5%), rather than the upper end of the 3% to 6% target range. This change in policy emphasis is partly being driven by the fact that the inflation target is relatively high compared to other emerging economies. In addition, achieving a sustained lower level of inflation (4.5%) should help to improve SA’s international competitiveness as well as support some improvement in the stability of the rand exchange rate.

Encouragingly, the inflation rate is expected to moderate further over the next 6-12 months to an average of around 4.5%, dropping below 4.5% in the first few months of 2025. This view is supported by a very welcome easing of food inflation to just over 4% in May 2024 (despite earlier fears about the potential impact of an El Niño weather effect), a decline in fuel prices and the recent outperformance of the rand exchange rate.

It is also encouraging that core inflation has been inside the target range for the past 37 months, remaining unchanged at 4.6% in May 2024. A core inflation rate of around 4.5% would argue strongly in favour of the Reserve Bank starting the interest rate cutting cycle, especially since the repo rate is well above inflation at 8.25%.

This raises two important questions. First, can SA start cutting interest rates prior to the commencement of the interest rate cutting cycle in key developed markets – especially the US? Second, can SA achieve a sustained lower average inflation rate, thereby justifying a meaningful reduction in the SARB’s inflation target? This something the government is in the process of investigating.

Emerging economies have started cutting interest rates

In the past 12 months, a total of 38 central banks have commenced their own interest rate cutting cycle. This is measured out of a total of 80 central banks that we monitor on a regular basis. At least 18 of them have cut rates on three or more occasions over the year, all of which are either emerging economies or developing countries. These rate cuts were implemented prior to the start of the European Central Bank’s rate-cutting cycle and, in general, preceded all the recent rate cuts in developed markets – which now include Switzerland, Sweden, Denmark, Canada and the euro area.

Successive interest rate cuts by five emerging economies are worth examining in more detail, namely Brazil, Chile, Peru, Hungary and the Czech Republic. All five countries started cutting rates between July 2023 and December 2023. They have all cut rates on at least four or more occasions in the past year (Chile has reduced rates on nine separate occasions, while Hungary and Peru have reduced rates eight times over the past year), and they have all lowered interest rates by between 175 bps and 575 bps.

It is also interesting that all five emerging economies started cutting interest rates before their inflation rates were fully under control. For example, when Chile started cutting rates in July 2023, its consumer inflation rate was measured at 6.5%, which is well above the inflation target of 3%. Subsequently, inflation rates moderated further, but remain elevated at 4.1%. Under these circumstances, it is not surprising that the Chilean currency has weakened by a substantial -15.3% over the past year against the US dollar. This compares with a 10-year annual average currency depreciation of -5%. The central bank of Chile remains confident that it will achieve its inflation target of 3% over the next two years and it is likely to cut rates further in 2024.

The currency performance of the other four emerging economies over the past year has also been weaker than average, ranging from -5.1% for Peru to -13.1% for Brazil. Clearly, the risk of some currency weakness has not deterred these emerging economies from easing monetary policy in an effort to soften the negative impact of sustained high interest rates, especially when interest rates have risen to well above the rate of inflation.  

SA’s relatively high interest rates, weak economic performance, progress in bringing headline inflation back inside the target range of 3% to 6% in each of the past 12 months, as well as the fact that (as mentioned earlier) core inflation has been inside the target range for the past 37 months, suggest that the SARB should already have embarked on its own interest rate cutting cycle.

Two important factors may help to explain the Reserve Bank’s very cautious approach to monetary policy. The first is that the Monetary Policy Committee (MPC) would have been concerned about the increased vulnerability of the rand heading into the National Election on 29 May 2024. It would have feared that cutting rates prior to that event may have precipitated pronounced currency weakness, which would probably have been exacerbated by an election outcome that raised significant concerns among domestic and foreign investors. The second is that the MPC has been consistent in highlighting that SA’s inflation target is effectively 4.5% and having inflation hover around the top end of the target range undermines the performance of the economy.

Encouragingly, the election outcome received a favourable response from financial markets and SA’s inflation rate is expected to moderate further over the coming months. This would allow the Reserve Bank to commence the interest rate cutting cycle in Q3 2024.

Overall, there is sufficient evidence to suggest that emerging economies have not become entirely beholden to the interest rate cycle in the developed world, especially the US. This does not mean that they do not pay close attention to global interest rate trends. Instead, it suggests that many emerging market central banks are willing to adjust interest rates based primarily on domestic economic circumstances – including their success in getting inflation under control – while remaining mindful of the impact this could have on global capital flows into and out of their economies.