Big change to interest rates in South Africa

The Reserve Bank recently introduced two new inflation measures that will change how interest rates are set in South Africa.

This is according to Ninety One economics analyst Sisamkele Kobus and investment director Vivienne Tabererer, who unpacked how these new tools will influence future monetary policy decisions in the country.

The primary purpose of the South African Reserve Bank (SARB) is to achieve and maintain price stability in the interest of balanced and sustainable economic growth. 

Like most other central banks, the SARB targets inflation as its anchor for price stability. Currently, the SARB has a headline inflation target of 3% to 6%.

However, while the SARB targets headline inflation, it also pays significant attention to underlying inflation. 

This metric gives the bank insight into the longer-term direction of headline inflation to ensure it can implement appropriate monetary policy.

This is because headline inflation is susceptible to short-term shocks. It can be volatile, with a high noise-to-signal ratio. 

Kobus and Taberer said these underlying inflation measures are designed to try and filter out these temporary price movements and identify the sticky parts of inflation.

Central banks most often look at core inflation, which typically removes seasonal fluctuations and volatile inputs such as food and energy prices, and the SARB is no exception. 

Various other underlying inflation measures have been developed, including trimmed mean inflation, weighted median inflation, persistent and common component of inflation (PCCI) and supercore inflation.

The SARB recently released a special occasional bulletin that presented new inflation measures to help unpack underlying inflation pressures that may not be picked up by traditional measures like headline, core, and trimmed mean inflation. 

The Reserve Bank introduced two new inflation measures – supercore inflation and the PCCI – to complement its existing metrics.  

Bloomberg reported that both of these new measures will be considered together with Statistics South Africa’s headline and core inflation measures to inform monetary policy in the future.

Supercore inflation

The first new measure is supercore inflation. Kobus and Taberer said this metric largely follows the European Central Bank (ECB) methodology, as this new measure consists of components of core inflation that are highly sensitive to economic conditions. 

They explained that this metric, therefore, gives the SARB’s Monetary Policy Committee (MPC) a clue about whether inflationary pressures observed are supply- or demand-driven.

The SARB defines demand-side and supply-side inflation as follows:

• Demand-side inflation: When consumers spend more money, prices tend to rise faster. By contrast, when consumers are under pressure and spend less, prices rise more slowly. 
• Supply-side inflation: Inflation tends to decrease if it becomes cheaper to produce a good or service. For example, globalisation made it cheaper to produce manufactured goods such as clothes and electronics. Conversely, inflation could increase if it becomes more expensive to produce a good or service. For example, a drought raises food prices.

The SARB has previously been criticised for not adequately considering the impact of supply-related factors on the country’s inflation in its monetary policy.

For example, in 2023, PSG Wealth’s chief investment officer, Adriaan Pask, said interest rate hikes are not the right mechanism for fighting inflation in all environments – particularly in South Africa, where economic growth is limited.

Pask explained that monetary policy theory suggests higher prices are reduced by muting what is assumed to be cyclically higher demand. In other words, by targeting demand-side inflation.

However, in South Africa, “we don’t have too much demand, we clearly have too little, the economy is under significant pressure”, he said. 

Pask said much of what South Africans have been experiencing in recent years in the form of higher prices is related to issues on the supply side – like load-shedding – rather than driven by higher demand. 

Persistent and common component of inflation (PCCI)

The second new measure the SARB introduced is the PCCI. Kobus and Taberer said the key function of employing the PCCI is to determine persistence in inflation regardless of whether it is driven by supply-side or demand-side pressures.

“To be useful to monetary policy decision-making, both these measures must be less volatile than headline inflation and give insight into the direction of headline inflation,” they explained.

However, they noted that the MPC targets headline inflation and none of these new measures, including core inflation.

Despite this, the new measures can help to provide a better picture of the balance of risks to the inflation outlook. 

“If the measures show elevated and persistent inflation despite low headline inflation, the MPC could delay a rate-cutting cycle,” they said. 

“Conversely, if there is higher headline inflation, but persistent inflation pressures are subdued, it might provide room to maintain the current policy stance.”