Notes from my inbox

Money is, at its root, a rationing system used to provide access to the World’s wealth and resources. If the money supply is out of balance with the underlying economic reality, instability is likely to follow. Too much money will lead to an increase in inflation, while too little money in circulation will suppress economic growth and increase unemployment. Society entrusts central banks with the duty to maintain economic stability. It does this through setting policy interest rates and controlling the monetary supply by buying or selling government securities and setting reserve requirements for banks; which, in turn, controls how much money can be lent. A tighter, more hawkish policy stance typically acts as a headwind for financial markets, while a looser, more dovish stance is often supportive of asset prices.

The third quarter of 2024 proved no different. Its big macroeconomic policy event was the end of a lengthy period of hawkish monetary policy when the US Federal Reserve Board announced its first cut in interest rates in four years - by a bumper 0.5%. This supported strong performance from growth assets, with global equities up 6%, emerging market equities up 9%, and listed property up 16% over the three months (all in US dollars).

Domestic interest rates followed, with the South African Reserve Bank (SARB) announcing a more modest 0.25% cut in September. We expect another 0.25% cut in November, with a further 0.75% to follow in 2025. Domestic asset performance was even stronger than global markets’, supported by a stronger rand and the positive response to the formation of a centrist government after elections in May.

While domestic demand remains weak and with inflation well contained due to a strengthening rand and declining oil prices, many commentators are making the case that domestic interest rates are still too high. The current prime rate of 11.5% is still significantly higher than the 10% just prior to the onset of the Covid pandemic in early 2020. One reason for the policymaker keeping rates higher than historical norms is the debate about lowering the inflation target.

The rationale for a formal inflation target is to enhance transparency and credibility and to make it easier to manage inflation expectations in the economy. South Africa (SA) introduced a formal target in 2000, with a target range of 3% to 6%. This was intended to gradually reduce to between 2% and 4%, but this reduction was never implemented. Since 2021, the SARB has resurrected the debate, arguing that the target should be reduced to 3% to better align SA with global norms. One of the key arguments in favour of a lower target is that lower inflation will lead to a more stable rand, which will make domestic investment more attractive.

However, lowering the target comes with definite short-term and potential long-term costs. In the short term, some economic growth needs to be sacrificed as interest rates will remain higher for longer. In the longer term, credibility will be sacrificed if the new target is not consistently met, reducing the attractiveness of SA as an investment destination. Elevated public debt levels and a track record of government inefficiency, expressed in consistent above-inflation increases in administered prices, such as water and electricity, increase the long-term risks. Weaker economic growth in the short-term could test the patience of the factions required to keep the ruling coalition together. As always, economic policy remains a complex trade-off that needs to be made under the conditions of uncertainty.

As a reminder, I invite you to contact us via clientservice@coronation.com if we have failed to live up to your expectations in any way.

I hope you enjoy this edition of Corospondent

^{Insights Disclaimer}