Kganyago’s short-term pain, long-term gain for South Africa

Reserve Bank Governor Lesetja Kganyago said lowering and narrowing the country’s inflation target could lower South Africa’s interest rates, potentially dropping the repo rate to just under 6%.

He added that while economic growth would initially be slower with a lower inflation target, as interest rates go down, growth would pick up over time.

The debate around South Africa’s inflation target has been ongoing for years, but intensified recently when the Reserve Bank and National Treasury entered official talks.

Inflation targeting is a framework in which a central bank uses monetary policy tools, especially controlling short-term interest rates, to keep inflation in line with a given target.

The Reserve Bank has used this framework since 2000 and currently targets a range of 3% to 6%, with the midpoint of this range, 4.5% being the ideal.

Kganyago has been a staunch proponent of South Africa adopting a lower and more narrow target, ideally 3%.

Previously, the governor explained that this lower target would better align with international standards, benefit fiscal policy and lead to stronger growth.

“A lower target, sitting at 3%, would help dampen exchange rate volatility and sovereign risk, reduce the potential for upward drift in the real exchange rate, and materially lower debt service costs, primarily for the now over-indebted public sector,” he said.

His sentiments seem to be echoed within the National Treasury as well. Recently, South African Reserve Bank Deputy Governor Fundi Tshazibana said there is general agreement that the country’s current inflation target range is too broad.

The central bank and the Treasury have been in talks on a new inflation framework since February 2024.

On 22 May 2025, Tshazibana said the technical teams conducting the discussions will give their recommendations soon.

“Where we have landed is that there’s a broad consensus among us that our range is too wide and out of line with that of our trading partners,” she said.

On 29 May 2025, the Reserve Bank’s Monetary Policy Committee (MPC) met to vote on whether to adjust South Africa’s interest rates.

The committee ultimately voted to cut rates by 25 basis points, citing lower inflation projections and more balanced risks to this outlook.

In the announcement of this decision, Kganyago also outlined how a lower inflation target would affect interest rates in the country.

Lower target, lower rates

Kganyago explained that, while the current inflation outlook appears benign, the MPC considered various alternative scenarios to see how different factors would influence monetary policy in the country.

The first alternative scenario illustrated the upside risks to the inflation outlook.

“This was based on a global slowdown, triggered by escalating trade tensions, where the rand depreciates sharply,” the governor explained. 

“The scenario showed how a country with some fundamental vulnerabilities, like South Africa, risks stagflation, with growth moving lower while inflation rises due to currency weakness.” 

“In these conditions, monetary policy tightens to stabilise the macroeconomy.”

The second alternative scenario considered how interest monetary policy would adjust to a 3% inflation target.

The governor explained that, for some years now, internal and external analysis has shown that South Africa’s inflation target is too high and too wide. 

“The National Treasury and the South African Reserve Bank have engaged extensively on this issue, and technical work is at an advanced stage,” he said. 

“Now that inflation has slowed, we have a chance to lock in lower inflation at low cost. This scenario illustrates that opportunity.”

Therefore, for a 3% objective, the central bank’s Quarterly Projection Model shows a lower path for interest rates. 

He explained that both the central bank’s baseline and the 3% scenario have a cut in this quarter. 

“However, rates move steadily lower in the scenario as inflation comes down. The policy rate falls to just under 6%, rather than staying above 7%, as in the baseline,” he said. 

“Inflation expectations stabilise at 3% during 2026, helped by the experience of lower inflation.”

He warned that growth in this scenario would be somewhat slower at first because real rates are initially higher. However, he said the economy does better later in the forecast, as rates ease further.

“The MPC is of the view that the 3% scenario is more attractive than the 4.5% baseline, and we would like to see inflation expectations move lower, towards the bottom end of our target range,” he said. 

“We will also consider scenarios with a 3% objective at future meetings.”