Why is the SARB Cutting Interest Rates Cautiously

During their November meeting, the South African Reserve Bank (SARB) cut interest rates by only 25 basis points. Many people, some investment specialist included, felt that a bigger cut of 50 basis points would have been more appropriate. In this article, we will take a closer look at not only why the SARB exercised more caution by cutting interest rates by only 25 basis points, but we will also unpack what the SARB’s role is to help us better understand how they make decisions.Whether you are an experienced investor or just want to make informed decisions about your personal finances, interest rates, and the changed made to them, will directly and indirectly affect you and therefore understanding the factors that affect them are important.

Let us first understand why some expected a bigger rate cut. As many know, the SARB considers Consumer Price Index (CPI), a measure of inflation, as an important benchmark when making decisions about the interest rates. The SARB aims to maintain CPI between a target range of three and six percent. Following supply chain shortages locally and globally due to the pandemic in 2020, as well as government stimulus packages that increased money supply, inflation increased and has been elevated up until the first half of 2024. Inflation has however been coming down over the last few months and the latest data showed that CPI eased to 2.8% in October, the lowest it has been since June 2020. This means that inflation is below the target range and therefore many expected the SARB to incorporate this metrics into their rational when considering the rate cut.

So why did they not cut interest rates more aggressively to stimulate economic activity given that inflation is clearly no longer a problem? Because the SARB’s main mandate is not keeping inflation within the target range, although price stability is their ultimate goal. The primary mandate of the SARB, as is clearly stated on their website, is to protect the value of the currency. This means that they will not influence inflation and economic growth at the cost of the currency. It is therefore absolutely key to understand that they consider the value of the currency as one of the main driver of inflation, economic growth and wellbeing of the South African economy.Let us unpack why this is. The South African rand is widely considered one of the most volatile currencies in the world, and since we are a small, open economy we import over 30% of our GDP’s worth of goods and services, with oil, an important input cost into nearly all goods and services, the most imported good. If the price of oil, which is priced in US dollars, are subject to too much volatility and uncertainty, it becomes difficult for local businesses to plan around these price fluctuations. If the rand weakens too much against the US dollar, it will ultimately lead to heighten inflation and the SARB will not be able to maintain their target range inflation.

But how is the SARB influencing the value of the rand by adjusting interest rates? South Africa, an emerging economy, inherently holds more risks for investors as compared to developed economies such as The United States or Germany for example. As such investors demand higher returns to invest in emerging economies to justify the increased risk their capital will be exposed to. Interest rates generally set the minimum return investors can expect to receive as they can place their funds in a liquid bank account at relatively low risk. If the SARB lowers interest rates too aggressively it will cause international investors to withdraw their funds from South Africa as they might feel the risk return pay off does not make sense anymore. When they withdraw their funds, they will effectively sell their rands, causing the value of the rand to depreciate.

The Federal Reserve Bank (Fed) of the United States are signalling that they might be more cautious in lowering their interest rates as their inflation outlook is looking less likely to be under control with geopolitical tension rising and uncertainty around how Trump will implement his policies.  If the Fed keeps their interest rates elevated, the SARB can not drop their rates to be lower than those investors will receive in the US as it will cause a massive outflow of capital as explained above, causing the rand to weaken.It is clear that many factors play into the SARB’s decision and that it is not as straight forward as only considering inflation numbers. With many uncertainties still looming in 2025, the SARB will probably continue to lean more towards a conservative approach. Although many South Africans are desperate for some relief it is important to understand that the SARB still has your best interest at heart, even if it is a bit of tough love keeping rates elevated slightly longer.