We continue to walk the monetary policy tightrope

We have seen a cautious pause in the rate cutting cycle

The major developed market central banks were cautious in July, both in terms of their policy actions and guidance. The European Central Bank retained its refinance rate at 4.25% at its July policy meeting and gave no clear indication of its policy path in the coming months. With lingering concerns on the sustainability of the recent cooling in inflation, Christine Lagarde and her Governing Council colleagues continued to caution against cutting interest rates too quickly and unwittingly ingraining elevated inflation expectations.

Across the Atlantic, the US Federal Open Market Committee also voted to leave the Fed Funds Rate unchanged at a 5.50% upper bound at its July meeting, but left the door open for potential monetary policy easing in September. The US economy faces a wide inflation gap, with year-on-year consumer price inflation stuck well above its 2% target level – largely on account of elevated services inflation. However, inflation expectations remain reasonably contained and the employment market is showing increased signs of cooling. Coincidentally, the softening in wage inflation and employment statistics coincides with the depletion of the savings pool that built up during the COVID pandemic. This confluence will support the gradual softening of inflation outcomes and lend support to the arguments for an imminent easing in monetary policy. While developed market central banks are broadly consumed with suitably calibrating the timing and pace of policy easing, the Bank of Japan continued its monetary policy normalisation process by hiking its policy rate by 15 basis points to 0.25% and further tapering its asset purchase programme.

 Figure 1: Real central bank policy rates

Source: Bloomberg, Futuregrowth

Domestic inflation expectations nudge lower

Domestic headline consumer price (CPI) Inflation receded to 5.1% year on year in June from 5.2% in May. This print was in line with market expectation, arresting the recent trend of downside surprises. The marginal cooling in inflation was driven by moderating energy and food price pressures, against our expectations of upside risk stemming primarily from the El Niño weather pattern and the related cuts to domestic white maize harvests.

Moreover, the latest inflation survey from the Bureau for Economic Research reveals lower inflation expectations for the current year and forecast horizon from analysts, business leaders, and trade union officials. While adjusting lower, these expectations nonetheless remain anchored above the 4.5% mid-point of the South African Reserve Bank (SARB) inflation target band and will feed into continued caution on the timing and magnitude of the domestic interest rate cutting cycle. Healing price pressures in the third and fourth quarters of this year will provide a window of opportunity for interest rate cuts, allowing a shallow and gradual interest rate cutting cycle from the prevailing 8.25% nominal repo rate.

Figure 2: South Africa Forward Rate Agreement (FRA) Rates

Source: Bloomberg, Futuregrowth

The break from loadshedding boosts sentiment

July marked another month of no loadshedding. Eskom’s weekly generation capacity reports continue to highlight the resilience in the electricity supply, with the energy availability factor (EAF) across the large coal-fired power plants, including the beleaguered Medupi and Kusile, hovering towards 70% in recent months – marking a remarkable turn from the near 50% EAF at the start of the year. Eskom has not implemented loadshedding since March 2024, with stabilised electricity generation feeding into improved business and investor confidence, a necessary precondition to stimulating macroeconomic growth in South Africa. The reform agenda driven by Operation Vulindlela has been instrumental in stabilising South Africa’s electricity production constraint. We now look to its influence in easing port, rail and logistics inefficiencies in the coming months and years.

Other high frequency macroeconomic indicators continually point to a strained economic backdrop and modest growth outlook for 2024, despite the marked improvement in electricity production. These include mining production, which recorded no growth in year-on-year terms in May, down from a mere 1.4% year on year in April. Private sector credit extension also grew at 4.3% year on year in June, marking an improvement from the 3.9% annual growth rate recorded in May. This headline reading belies the underlying weakness in household credit lending, which remains at 3.3% year on year. In real terms, credit extension has stalled and remains a headwind to aggregate economic growth. Credit lending standards have not been significant determinants of monetary policy in the current hiking cycle, but they nonetheless highlight the weakness of aggregated demand and will lend support to the arguments for monetary policy easing in the second half of 2024.

Fiscal strain eases

Fiscal year-to-date data suggests a continued trend of resilience in public finances. A buoyancy in monthly fiscal revenue receipts remains apparent – reflecting both an underlying resilience in the underlying economy, and efficiency gains by the South African Revenue Service (SARS) in recent times. It remains too soon to call a trend, but extrapolated year-to-date fiscal trends suggest high odds of an improvement in realised full-year metrics relative to the estimates tabled by National Treasury in the February budget.  

However, fiscal flexibility remains a constraint for government finances in the medium term. A small, open economy like South Africa remains significantly exposed to exogenous shocks, with little room to effect counter cyclical fiscal policy in the event of an economic downturn. Moreover, the hastily signed National Health Insurance Bill stands to further constrain government finances – although implementation was always due to be phased in over time and might yet be hindered by litigation and wrangling within the Government of National Unity (GNU). In our estimation, a growth rate approaching 3% per annum remains necessary to achieve debt sustainability within the current fiscal framework, and 5% per annum is needed to make inroads towards achieving inclusive growth and poverty alleviation.  

The liberalisation of our electricity production was a necessary precondition to stimulating economic growth. Other policy initiatives spread headed by Operation Vulindlela, including improving port and rail logistics, remain key watchpoints to unlocking higher levels of sustained economic growth.  

Figure 3: Realised main budget balance relative to budget expectations

Source: National Treasury, Futuregrowth

GNU tailwinds support long-dated nominal bonds

The domestic nominal yield curve shifted lower in July, driven by continued risk appetite for local bonds by domestic and foreign market participants following the formation of the GNU. ALBI +12 years was the best performing segment of the nominal bond curve, rendering a total return of 5.06% for the month relative to the ALBI total return of 3.96%. Cash, proxied by the SteFI Call Deposit Index, rendered a return of 1.59% for the month, with the IGOV Index, comprised of sovereign issued local currency inflation-linked bonds (ILBs), rendering a return of 1.80%.

Figure 4: Bond market index returns (periods ending July 2024)

Source: IRESS, Futuregrowth

/// THE TAKEOUT: The major developed market central banks were cautious in July, both in terms of their policy actions and guidance. The European Central Bank retained its refinance rate at 4.25% at its July policy meeting, with no clear indication of its policy path in the coming months. The US Federal Open Market Committee also voted to leave the Fed Funds Rate unchanged at a 5.50% upper bound at its July meeting, but left the door open for potential monetary policy easing in September. Domestically, Eskom has not implemented loadshedding since March 2024, with stabilised electricity generation boosting business and investor confidence, a necessary precondition for macroeconomic growth in South Africa. The reform agenda driven by Operation Vulindlela has been instrumental in stabilising South Africa’s electricity production. We now look to reduced port, rail and logistics inefficiencies in the coming months and years.