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Investing.com - South Africa’s economy likely has a much larger negative output gap than widely assumed, which will keep inflation around 3% rather than rising toward 4.5% as the Reserve Bank (SARB) and consensus expect, according to Capital Economics.
This economic slack should give policymakers room to cut the repo rate to approximately 5.75% next year from the current 7.25%, significantly lower than market pricing suggests. Inflation in South Africa has consistently surprised on the downside for nearly 18 months, with the May headline rate at 2.8% year-over-year, below the SARB’s 3-6% target range.
Capital Economics points to several indicators of this negative output gap, including fallen manufacturing capacity utilization and a sharp rise in unemployment since the pandemic. The country’s GDP has increased by less than 2% since 2019, while the labor force has grown almost 10% during the same period.
The research firm forecasts inflation will average around 3.5% next year, well below the consensus expectation of approximately 4.5%. This outlook suggests the SARB’s monetary easing cycle will continue, with the repo rate potentially declining to 5.75% by next year, about 100 basis points lower than current market pricing indicates.
Capital Economics notes that the likely move to a lower 3% inflation target should help reduce inflation expectations rather than pose a threat to monetary easing, though fiscal slippage remains the biggest risk to their monetary policy forecast.
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