The combination of ongoing low economic activity, the undervalued rand and a recent decline in inflation expectations suggest that inflation should not be a problem for the next two years.
This is according to the SA Reserve Bank, which released its biannual Monetary Policy Review (MPR) on Tuesday.
The Reserve Bank said interest rates would likely gradually rise after 2021. According to the central bank, both headline and core inflation rates will remain largely within the lower half of the target until the end of 2022 – the target is a range of 3% to 6%, which has been in place since 2000.
The rand is currently trading at about R17/$, weaker than the January 2020 average of R14.40/$ but much improved from early April lows of R19/$.
Rising government debt levels also present a risk to equilibrium interest rates in the future. Up to now, public debt has risen in most jurisdictions over the past decade without seemingly affecting the level of interest rates.
Speaking at the launch of the MPR, Reserve Bank Governor Lesetja Kganyago said the central bank’s latest projections were consistent with a rise in the policy rate to 4.0% by the end of 2021 and 5.0% in 2021. Kganyago said this would still be 100 basis points below the average of the past decade.
“The rate cut will take some time to affect the economy. In normal conditions the biggest effects arrive after 12 to 18 months,” said Kganyago, adding that by the middle of the year “monetary policy was mostly in wait-and-see mode, with some fine tuning but no big changes”.
In reaction to the Covid-19 coronavirus pandemic, the monetary policy committee lowered the repo rate by a cumulative 275 basis points between March and July to counter the impact of the pandemic.
The Reserve Bank also injected liquidity in money markets through larger and more frequent repo operations to facilitate the flow of credit to cash-constrained businesses and individuals.
It also temporarily relaxed some regulatory capital requirements for banks. Finally, it purchased government bonds in the secondary market to ensure liquidity and the smooth functioning of the bond market.
Kganyago said although monetary policy had provided substantial support to the economy – with the Reserve Bank cutting benchmark interest rates to a record low 3.5% – the pace of recovery would depend on factors outside the Reserve Bank’s control. These factors include improved sovereign debt sustainability and structural reforms, he said, adding that the Reserve Bank was just one player with a relatively narrowly defined role.
“The bank’s main contributions are protecting financial stability and controlling inflation. These things are necessary for balanced and sustainable growth, but they aren’t sufficient. Economic success will require contributions from everyone on the national team,” Kganyago said.
The MPR said this year’s load shedding had been the worst yet, despite a huge slowdown in economic activity. It states that new power stations don’t work properly and that old ones haven’t received necessary maintenance, therefore progress on adding additional capacity has been slow.
According to the review, power shortages will continue to hamper economic activity and deter people from making new investments.
Kganyago added that the Reserve Bank expected the economy to contract by 8.2% in 2020.
“From what we know, a repo of 3.5% looks about right, but this judgement isn’t set in stone. Our best estimates now are that the economy will continue to recover and inflation will rise back to about 4.5%. As a result, interest rates are likely to gradually rise after 2021 but remain on the low side, as seen from a longer-term perspective.”
He said that adding rate cuts in the early stages of lockdown helped people with existing debt by reducing interest costs. Now that restrictions on economic activity have been eased, low rates are encouraging people to borrow for new purchases.
According to the Reserve Bank, the number of new mortgages granted has climbed to a 10-year high.
“It is clear that some households are under intense pressure from lost jobs, and the outlook for the economy is uncertain. But we are still seeing demand for credit,” said Kganyago.
He added that low interest rates were helping government borrow more cheaply.
“Despite losing investment grade status, government’s average interest rate has declined this year. This is happening, in part, because the National Treasury is issuing more short-term debt, which is closely tied to the low repo rate set by the Reserve Bank,” he said.