Words on wealth: why are interest rates still high when inflation is so low?

Inflation is something we can’t avoid – it’s a bit like death and taxes. Traditionally, South Africa has had high inflation in comparison with developed countries, and that’s a fundamental reason why the rand has steadily declined against the currencies of those countries. The Covid-19 pandemic upended that trend, and who knows what the effects of US tariffs will be. Whether we return to what now seems was a much safer, more stable world before Covid remains to be seen.

As of June, our year-on-year Consumer Price Index inflation rate was 3.0%. Over the years, the SA Reserve Bank (SARB), through controlling interest rates, has done an admirable job of keeping inflation within its target range of 3-6%, for the most part.

In comparison with other African countries, our inflation is low. Zimbabwe is an obvious example of a collapsing economy with runaway inflation, but even in countries with stable, growing economies, inflation is a problem. Nigeria has inflation of over 22%, according to Trading Economics; Egypt’s rate is about 15%; and Rwanda’s is over 8%. Kenya and Namibia are in a similar band to us – their current rates are 3.8% and 3.7% respectively. Looking further abroad, Brazil’s rate is 5.4% and Turkey’s is a terrifying 35.1%.

Recently, the SARB has said it wants to bring the inflation target down so that 3% becomes the middle of the target band. Ironically, to do this, it would need to keep interest rates high, and I would suggest that they are too high as it is.

Inflation rate vs interest rate

In the following exercise, I compare the CPI inflation rate with the prevailing interest rate (the bank repurchase, or repo rate, as determined by the SA Reserve Bank). A fair comparison of the two rates involves percentages of percentages, which sounds complicated, but bear with me. 

Before Covid, inflation was averaging 4.5%, smack in the middle of the SARB's target range of 3-6%, and the repo rate was averaging 6.75%. Therefore, the repo rate was 50% higher than the inflation rate.

When Covid hit, the economy froze and inflation plummeted, reaching a low of 2.1% in May 2020. By then, the SARB had already started slashing the repo rate – it plunged from 6.25% in February 2020 to 3.5% at the end of July, remaining at that record low for over a year. For most of that time, between July 2020 and March 2021, inflation hovered around 3.1%. The difference between the two rates was minor: the repo rate was just 13% higher than the inflation rate.

By the end of the pandemic, inflation had soared, reaching a high of 7.8% in July 2022. Over the following two years, it steadily declined to 2.8% in October 2024, and it has averaged about 2.9% since then.

When inflation was at 7.8% in July 2022, the repo rate was 5.5% – in other words, the repo rate was about 30% lower than the inflation rate, in a rare reversal.

But by then, the SARB was rapidly hiking the repo rate to catch up with the high inflation, so that by July 2023, the repo rate reached a high of 8.25%. It remained there for a year, until July 2024, by which time inflation had dropped to 4.6%. The rates had righted themselves: the repo rate was now 80% higher than the inflation rate.

Fast forward to June this year. The repo rate at 7.25% is 142% higher than the inflation rate at 3.0%. That's an enormous difference, considering it was only 50% higher before Covid. Even with a drop to 7%, it will still be 133% higher than the CPI inflation.

This means that even in a bank savings account with a relatively modest 6% interest rate, you’re getting a substantial after-inflation return of 3%.

But while the high repo rate is great for savers, it’s terrible for borrowers – think of mortgage bond holders whose interest rates are high, but where inflation is not substantially increasing the value of their properties.

Juggling act

Things are not as simple as I have perhaps conveyed. The SARB’s rate decisions are forward-looking, and with the current uncertainty around tariffs, it has been justifiably cautious – inflation could rear its head again at any moment. On the other hand, keeping rates high unnecessarily is bad for economic growth. It’s a delicate juggling act, as beleaguered US Federal Reserve Chairman Jerome Powell knows all too well.

Commenting on the SARB’s low-inflation stance, FNB economists Mamello Matikinca-Ngwenya, Siphamandla Mkhwanazi, Thanda Sithole, and Koketso Mano say they think the shift will happen soon, with the SARB trying to take advantage of the currently benign inflation environment. But they say such a process takes time, and factors such as weather patterns, cyclical food inflation, and the need for traction on structural reforms may derail it. 

“We still anticipate inflationary pressures that will make it difficult to sustain the current rate of inflation and believe that the SARB will have to work towards a 3% target as a medium-term objective,” the FNB economists say.

Foord chief investment officer Nick Balkin says SARB’s thesis is that a lower inflation rate will shrink Treasury’s debt‑service bill and release scarce funds for social priorities. But although the SARB has generally delivered on its mandate to keep prices stable within its target range, he says real economic growth has barely averaged one per cent a year since 2014. “Stabilising prices has not unlocked capital expenditure or boosted economic growth. If anything, it was the weaker growth that helped keep inflation in check,” Balkin says. “Without meaningful, structural state interventions to address the root causes of constrained economic growth, the debt burden may even worsen.”

* Hesse is the former editor of Personal Finance.

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