Interest rate warning from the SA Reserve Bank

South Africa’s path to lower inflation has become less certain and is being “frustrated” by elevated food prices and volatile energy costs.

This was the warning from the South African Reserve Bank (SARB), which said interest rates may be kept higher for longer than previously expected.

Despite inflation falling back within the central bank’s 3% to 6% target band and staying there since June last year, it has hovered well above the 4.5% midpoint, where it prefers to anchor expectations.

“These setbacks suggest that the path back to the 4.5% midpoint of the target band is likely to be bumpy and protracted,” the South African Reserve Bank said in its six-monthly Monetary Policy Review.

The relatively slow disinflation seen up to now is “likely to keep rates at current levels for longer than previously expected,” it said.

One of the main pressures stems from services inflation, which the bank is forecasting will rise sharply to 5% this year, relative to 4.2% in 2023. It expects it to remain elevated at 4.7% in 2025.

“With some of the risks associated with services inflation having materialized, and an increase of other services components – including housing – to more normal levels expected, uncertainty regarding the path of disinflation has increased,” the Reserve Bank said.

The risks “indicate that the job of bringing inflation back to target sustainably is not yet complete,” the central bank said.

The Reserve Bank’s caution underpins policymakers’ inaction on interest rates since May last year, having kept the benchmark interest rate at a 2009 high of 8.25% for five straight meetings.

The Reserve Bank also flagged that long-term inflation risks are higher than they should be, owing to a high public debt burden and elevated credit default risks, adding that fiscal policy needs to support its monetary policy efforts.

“Domestic economic conditions can be improved by achieving a more prudent public-debt level,” the bank said. “The fiscal balance is subject to risks such as support to ailing state-owned companies and higher-than-budgeted wage bill growth over the medium term.”

South Africa’s economy would also benefit from a move to a single-point inflation target, which would give it a permanently lower inflation profile and reduce borrowing costs than its current target band, the bank said.

Governor Lesetja Kganyago, who has heralded a point target of 3%, has previously said the bank together with National Treasury are working on a framework that will decide on what form a new target should take.

Reserve Bank has two new CPI gauges

The South African Reserve Bank has developed two new measures to better understand underlying price pressures, and both currently show elevated readings.

A supercore measure plus a gauge dubbed the “persistent and common component of inflation” will be used alongside headline and core price growth published by Statistics South Africa as additional tools to inform monetary policy, said Witness Simbanegavi, the editor of the SARB’s biannual Monetary Policy Review.

The PCCI is higher than core inflation, which stood at 4.9% last month, mainly reflecting the below-average post-pandemic housing inflation and medical aid inflation, according to the review.

The supercore measure also shows that inflation pressures have risen as the economy recovered from the Covid-19 pandemic, with outcomes hovering slightly above the target midpoint in recent months.

Risks to underlying inflation include price growth expectations, the normalization of health insurance and rental housing inflation and currency weakness, the report said.

South African inflation has been above the 4.5% midpoint of the central bank’s target range where it prefers to anchor expectations since May 2021.

The MPC has left the benchmark interest rate at 8.25% since May in a bid to return it to that goal.