Reserve Bank Governor Lesetja Kganyago’s hands are tied

Interest rate hikes are not the solution to containing rising prices across South Africa’s economy, yet the South African Reserve Bank may have no choice but to stay tough on inflation.

This is because the Reserve Bank needs inflation expectations to be anchored at or close to its new 3% target, and appearing indifferent to rising inflation could send the wrong message.

If higher inflation expectations become embedded, South Africa could risk far more damaging consequences for its economy.

In a recent press release, PSG Wealth chief investment officer Adriaan Pask unpacked these dynamics in South Africa’s interest rate landscape – and the tough position the SARB finds itself in.

Pask explained that April’s CPI print, which showed inflation rising to 4%, underscored the difficult trade-off facing policymakers.

Policymakers are currently forced to find a balance between protecting a fragile consumer and a weak economy, or moving early to prevent inflation expectations from becoming entrenched.

South Africa’s rising inflation – expected to accelerate even further in the coming months – is being driven largely by rising fuel prices, which have a knock-on effect on transport and input costs across the economy.

“For households already under pressure and for an economy still struggling to generate meaningful growth, that is unwelcome news,” Pask said. 

Aside from households, he said these inflationary pressures also put the SARB in a difficult position.

On the one hand, South Africa’s rising inflation is clearly fuelled by supply-side pressures, rather than a booming economy and rising demand-side pressures.

“Growth remains subdued, consumer balance sheets are stretched, and the broader economy is still highly sensitive to any further erosion in disposable income,” Pask said. 

“Under those conditions, higher interest rates risk adding pressure to exactly the segment that has been carrying much of the economy: the consumer.”

In addition, he pointed out that interest rates are not the solution to easing supply-side inflation pressures. While rate hikes can dampen demand, they cannot lower oil prices or remove structural bottlenecks.

Reserve Bank Governor Lesetja Kganyago acknowledged as much in a recent public lecture, saying that monetary policy cannot do much about first-round effects from the ongoing Middle East war.

“Our interest rate tool does not change global oil prices – and it also operates with a lag: if we move rates now, the main effects on the economy play out next year,” Kganyago explained. 

“This timeframe means you cannot do much about inflation that is suddenly going to be higher next month. It is not in the window that is relevant for monetary policy.”

Trade-offs

Despite the limited power of interest rate hikes in the face of current inflationary pressures, Pask said the Reserve Bank also cannot afford to simply look through the April CPI print.

This is because the central bank is chasing its new 3% target, and has been clear that it wants inflation expectations anchored closer to this target.

“If policymakers appear indifferent to a renewed acceleration in inflation, they risk a more damaging outcome,” Pask warned. 

A more damaging outcome would be higher inflation expectations becoming embedded in wage demands, price-setting behaviour, and investor sentiment. 

“Once that happens, the cost of restoring credibility becomes much higher,” he explained. “If inflation risks are left unanswered early, the danger is that medium- to longer-term inflation starts to settle at a higher level.”

“For a central bank, that is a far greater threat than the discomfort of taking a cautious tightening step in the near term.”

“It is also not only a domestic issue. Monetary credibility matters for the currency, for capital flows, and for the confidence foreign investors place in South Africa’s policy framework.”

Therefore, Pask said the case for tighter policy, however reluctant, cannot be dismissed, even though further interest rate hikes could negatively impact South Africa’s economic growth.

Tighter monetary policy would further strain South African mortgage holders, vehicle finance customers, and businesses dependent on discretionary spending. 

“Retailers and other interest-rate-sensitive sectors are likely to remain vulnerable if borrowing costs stay higher for longer,” he said.

The real solution

With South Africa’s inflation challenge increasingly shaped by supply-side pressures, the Reserve Bank is essentially tasked with managing a problem that monetary policy can only partly solve.

The full solution to South Africa’s inflation problem will therefore require an additional policy response focused on lowering input costs across the economy.

“South Africa’s inflation challenge is increasingly shaped by supply-side realities: energy costs, fuel prices, logistics constraints and other structural inefficiencies that raise the cost of doing business,” Pask explained. 

“Lowering input costs through energy reform, improving logistics efficiency, reducing regulatory friction and supporting a more competitive operating environment would do more to ease inflation sustainably than relying on the interest-rate tool alone.”

Positively, Pask said the government seems to realise this, and encouraging signs have emerged, including measures to cushion fuel-price pressure, the gradual opening of the electricity market, and attempts to improve logistics performance.

However, he warned that reforms work with a lag, and markets will want to see consistency, continuity, and execution before they assign meaningful confidence to the growth outlook.

“Despite the fragility of the recovery, the Reserve Bank may still have to lean against inflation now,” Pask said. 

“The more durable solution, however, lies in reforms that reduce supply-side costs, improve productivity, and give South Africa a stronger, more sustainable growth platform.”