SARB keeps monetary policy in restrictive territory At the November meeting, the Monetary Policy Committee (MPC) cut the repo rate by 25 basis points (bp) to 7.75% and did not discuss a 50bp cut. The Governor’s speech described inflation as well contained and the risks to inflation as balanced albeit that uncertainty has increased over the longer term. The inflation forecast was revised lower in 4Q24 and 1Q25 from 3.6% and 3.7% to 3.2% and 3.5% respectively. It remains at 4.0% in 2025 on average, well below the 4.5% target.
Importantly, if the SA Reserve Bank (SARB) continues to cut by only 25bp at each of the next three meetings, to 7.0%, the real policy rate which is currently 5.2%, will average 4.0% over the next seven months. This should be considered highly restrictive compared to the SARB’s estimate of the neutral real rate of 2.7% and increases the tail risk of a 50bp cut at one of the next two meetings – although the probability of tail risk materialising is still minimal. Maintaining the real rate at this level for an extended period may see critics raise suspicions that the SARB is implicitly adopting a lower inflation target without making a formal announcement.
Figure 1: Real policy rate projection assuming a 25bp cut per meeting to 7.0%
Source : Stats SA, SARB, Matrix
The SARB justified its decision to cut by only 25bp, as opposed to 50bps, citing uncertainty and medium-term risks to wages, food prices, electricity tariffs (now expected to increase 13.3% next year and 12.3% in 2026), water and insurance. Interestingly, wage inflation remains of concern to the SARB, despite the Bureau for Economic Research’s (BER’s) 2-year inflation expectations having fallen to 4.8%, and the SARB anticipating that they will fall further from current levels. The oil price is expected to average $78/barrel (bbl) next year, in line with its 2024 average.
SARB’s forecasts bake in a domestic growth recovery. Although near-term growth may disappoint, GDP is forecast to rise to around 2.0% in 2027 by both SARB and National Treasury. Growth risks are balanced. The more positive outlook was highlighted by S&P’s upgrading SA’s credit rating outlook from BB- stable to BB- positive in November.
SA inflation outlook has improved
In our view domestic inflation will be structurally lower over the next 18 months. Our analysis of October’s CPI print shows that the pass through, or second round effects, of higher rand and fuel price inflation, appears to be zero. Second round effects of electricity tariff increases may now be negative, as households and businesses rely less and less on Eskom-generated power. This is evident in lower core inflation which fell to 3.9% in October from 5.0% at the start of the year; the SARB now expects core inflation will average 3.9% in 2025.
Despite the improved outlook, the SARB’s Quarterly Projection Model (QPM) or gap-model expects a terminal policy rate of 7.3% by the end 2026, up from 7.1% at the September meeting.
Why SA needs to run relatively restrictive monetary policy
As a high beta country, South Africa’s monetary policy is dictated in large part by the need to keep the Exchange rate as stable as possible in the face of uncertain global capital flows. The global risk backdrop is not yet conducive to investors deploying significant amounts of cash into emerging markets in their search for yield. Despite reduced domestic risks, SA’s monetary policy may need to remain restrictive relative to domestic GDP growth. Dollar strength, commodity price weakness and SA’s heightened geopolitical risks post Donald Trump’s US presidential election victory require that the SARB reinforce its credibility and support the exchange rate via high real rates.
US protectionism is likely to impede the global business cycle recovery, which should benefit the US dollar’s safe-haven status. The dollar is also being driven by the relative attractiveness of the US versus the EU as the US soft landing narrative remains intact. US economic outperformance versus the EU will increase if 10% to 20% tariffs on EU exports are implemented, and if Trump follows through with fiscal stimulus. US outperformance means that USD yields will remain attractive relative to EUR yields, as currently implied by the divergence of US and EU interest rate derivatives.
Weak global growth will also affect the commodity price outlook, which is clouded by China’s stubborn unresponsiveness to stimulus. The strong dollar outlook will be challenged if the US Federal Reserve Bank’s (Fed’s) independence were to be seriously tested. USD strength poses a cyclical risk to South Africa’s improved structural inflation outlook. In this context we note that the SARB’s CPI forecasts are based on the real effective exchange rate of the rand appreciating over the next three years on average. Our own forecasts assume the USD/ZAR will trade around a midpoint of 18.00 over the next six months, within a 50-cent range i.e. between 17.50 and 18.50, and assumes a US Dollar Index (DXY Index) of 103. Thereafter we see the currency’s midpoint depreciating to 18.60 to the end of 2025.
The growth inflation trade-off supports higher real rates
Critics of hawkish monetary policy argue that restrictive monetary policy will constrain potential growth momentum post the GNU. They cite that a real policy rate of between 3.0% and 4.0% is well above current real GDP growth of 0.5% year-on-year (y/y), and our potential GDP growth estimate of 0.95% y/y (Figure 2).
Figure 2: Difference between trend and actual GDP is narrowing
Source: Stats SA, Matrix
Theoretically, monetary policy can only affect the cyclical components of growth (Figure 3), such as the consumption of durable and semi-durable goods and investment in machinery and equipment. Policy rates have very little to no impact on potential or trend GDP, also known as structural growth (Figure 4). Dissecting South Africa’s growth-inflation trade off we highlight that SA’s cyclical GDP growth has become increasingly shallow since 2010 (Figure 2). Given the reduced amplitude of SA’s growth cycle, the trade-off has been substantially reduced and favours fighting inflation as the opportunity cost of lost GDP growth is minimal.
Figure 3: Real repo versus Cyclical GDP: Monetary policy impacts the growth cycle
Source: Stats SA, Matrix
Figure 4: Real repo does not drive potential/trend growth
Source: Stats SA, Matrix
Although domestic CPI has surprised marginally to the downside for the last nine months, we agree with the SARB’s insistence on providing enough fiscal and monetary policy space to be flexible in the face of unexpected events
