Africa-Press – South-Africa. South Africa’s window of opportunity to lower its inflation target and mitigate some of the volatility that would result from this change is closing.
Stabilising South Africa’s inflation at about 3% could reprice the entire structure of the country’s interest rates lower and give the country much-needed economic momentum.
This is according to Allan Gray investment analyst Sandy McGregor, who recently outlined the potential benefits of lowering South Africa’s inflation target.
The Reserve Bank and the National Treasury have been in talks to lower the country’s inflation target for months, with no official change announced yet.
Inflation targeting has been the Reserve Bank’s preferred approach to monetary policy since 2000, with the current target range of 3% to 6% having been in place since the turn of the century.
Reserve Bank Governor Lesetja Kganyago and many other financial experts have strongly supported lowering and narrowing the target, believing it could have immense benefits for South Africa.
McGregor explained that the wide inflation target range South Africa settled on in 2000 addressed the political realities of the time, with the Reserve Bank focusing on the upper band of the range for the following 14 years.
“In the first decade after inflation targeting commenced, inflation averaged 6.2% but was very volatile, reaching a peak of 13.7% in August 2008,” McGregor said.
“It was only during Gill Marcus’s term as SARB governor between 2009 and 2014 that inflation settled down at about 6%.”
When Kganyago took over as governor in 2014, he interpreted the Reserve Bank’s mandate as requiring a target of 4.5%, the midpoint of the range.
This was achieved in 2019 when inflation averaged 4.2%. However, as many other central banks around the world, the Reserve Bank slashed interest rates to provide relief for struggling households during the Covid-19 pandemic.
Then, in response to the post-pandemic inflation shock, which saw South Africa’s inflation reach 7.6%, the repo rate was gradually increased, with the Reserve Bank implementing 475 basis points of hikes.
In response to this, inflation again started to decline, and in November 2024 reached a low of 2.8%. It has remained close to 3% ever since, as shown in the graph below, courtesy of McGregor.
Saving grace
With South Africa’s inflation now low and stable, the Reserve Bank recently announced that it would shift its preferred target from 4.5% to 3%.
It should be noted that this is not an official target change, with discussions with the Treasury still ongoing, but merely a preferred target.
McGregor said this decision was the Reserve Bank taking advantage of South Africa’s low inflation to “seize the opportunity” for a lower target.
He explained that inflation presents a significant threat to South Africans’ finances and disproportionately burdens the poor.
“While theoretically current interest rates impact future inflation, usually it is inflation that leads interest rates,” he said.
“The widespread claim that monetary policy is data-dependent is an admission of this truth. As inflation falls, so does the appropriate real rate.”
He pointed out that, in South Africa, inflation at 4.5% requires a real rate of about 2.5%, giving a nominal rate of 7%.
However, as inflation declines, the real rate required to promote price stability also declines. Therefore, with inflation at 3%, it will be about 2%, which implies the nominal rate should be 5%.
“The SARB is correct in saying that we are presented with an opportunity we should not miss. The journey to 3% inflation could be volatile,” he said.
“However, if inflation stabilises at about 3% the entire structure of interest rates can reprice lower.”
“South Africa is trapped in economic stagnation. The positive economic benefits arising from lower rates would contribute to getting the economy going again.”
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