Stars Are Aligning for South African Rate Cut as Policy Tightens

JOHANNESBURG (Capital Markets in Africa) – The “r-star” is pointing to a South African rate cut.

That’s the suggestion from a study published by the South African Reserve Bank, which calculates that the country’s so-called neutral real rate, or R* in the jargon of economists, had fallen to about 1.9 percent by the end of 2017, from as high as 5.4 percent before the 2008 financial crisis.

R* is the interest rate that would support economic growth at full capacity while keeping inflation stable. It cannot be observed directly, so policy makers use models to estimate the level. The South African researchers adapted those models for a small open economy, incorporating additional drivers such as domestic net savings and investment, South Africa’s country-risk premium, the rand exchange rate and commodity prices.

An actual real rate higher than R* would indicate restrictive monetary policy, while real rates below R* signal an accommodative stance. In South Africa’s case, the real rate — the benchmark policy rate minus the inflation rate — climbed to about 3 percent at the end of February, well above R* — assuming, of course, that R* is still around the 1.9 percent level.

“The neutral real interest rate is an important benchmark for monetary policy,” the researchers, led by Reserve Bank economist Lauren Kuhn, wrote. “Policy makers can use estimates of R* to assess whether the current policy stance supports or constrains growth which, in turn, either fuels or moderates inflation.”

When real rates rose above R* in July 2017, the Reserve Bank cut its repurchase rate by 25 basis points, the first reduction in five years. Another rate cut followed in March 2018 as the real rate continued climbing. In November, the central bank unexpectedly lifted the benchmark lending rate after real rates fell to the lowest level in more than a year.

Forward-rate agreements, used to speculate on interest rates, are pricing in about a 20 percent chance of a 25 basis point rate cut by the end of this year. As recently as two weeks ago, they were pricing in a rate increase. The next Monetary Policy Committee announcement is scheduled for March 28.

Source: Bloomberg Business News