Best news for inflation and interest rates in four years

For the first time in four years, inflation expectations for the current year have fallen below 4%, indicating that there is greater room for the Reserve Bank to cut interest rates. 

This was revealed in the second-quarter inflation expectations survey from the Bureau of Economic Research, which outlined how individuals expect inflation to play out in the near future. 

The inflation expectations of all three social groups, business people, trade union representatives, and analysts, declined across the forecast horizon. 

On average, the respondents expect headline consumer inflation to be 3.9% during 2025, rising gradually to 4.3% in 2026 and 4.5% in 2027. 

This is far below the expectations of economists earlier in the year, who had predicted inflation to pick up beyond the Reserve Bank’s midpoint of 4.5% in the second half of 2025. 

Headline inflation remains below the bottom-end of the Reserve Bank’s 3% to 6% target range, with the latest reading showing price increases accelerated marginally to 2.8% year-on-year. 

Crucially, at its current levels, all key measures of inflation, across headline, core, goods and services, remain below the midpoint of the Reserve Bank’s target range. 

These domestic factors have been coupled with easing trade tensions between the United States and China, which significantly reduces the risk of a global recession and an inflationary spike.

As a result, all the groups surveyed by the BER made a downward revision to their five-year ahead inflation expectations, expecting a rate of 4.4%. 

The inflation expectations of households for the next 12 months decreased to 5.4%, from 5.7% before. This is the lowest rate since the fourth quarter of 2021. 

In contrast to their view on lower consumer inflation, the survey respondents upwardly revised their forecast of wage increases during the second quarter. 

They now expect salaries to rise by 4.9% this year and 5.1% next year, compared to 4.5% and 4.8% previously. 

All three social groups are now more pessimistic about economic growth. On average, they expect GDP to expand by 0.9% this year, compared to 1.2% before. For 2026, they anticipate growth of 1.2%, lower than the 1.4% expected during the first quarter.

Rate cuts threatened by target change

South Africa’s low inflation environment presents it with a good opportunity to lower its inflation target and change it from a range to 3%. 

The Reserve Bank has been calling for a lower inflation target, more in line with South Africa’s peers and some economists say it is already implicitly targeting 3% inflation. 

Momentum Investment’s chief economist, Sanisha Packirisamy, explained that such a change could result in interest rates being higher for longer. 

This would be needed to ‘lock in’ lower inflation and ensure the Reserve Bank’s credibility in meeting the new target. 

Sustainably lower inflation promises to bring immense benefits for South Africa, including faster economic growth and lower debt-servicing costs for the government. 

These are two of South Africa’s largest challenges, with an economy that has grown at an annual average rate of less than 1% over the past decade and a debt burden exceeding 75% of GDP.

The Reserve Bank recently released a white paper outlining the benefits of lowering the inflation target to 3% from the current 3% to 6% range.

Reserve Bank researchers argued in the paper that, in the long run, inflation in South Africa has proven to be far higher than that of the country’s major trading partners due to its wide target range. 

“Ultimately, better control of inflation should achieve stronger macroeconomic outcomes for South Africa,” the researchers said. 

“Inflation remains well above that of trading partners and the inflation premium in short-term and long-run interest rates is far too high, undermining investment.”

The researchers estimate that a lower inflation target of 3% can result in additional GDP growth of over 0.25% per year within five years and 0.4% within a decade due to improved economic competitiveness. 

These estimates are conservative, with the benefit set to be greater as lower interest rates ease the government’s debt-servicing costs and increase productive investment.

Lowering the inflation target also presents an opportunity to alleviate some of this pressure and will result in significant fiscal savings, as new debt will benefit from a stronger rand, lower interest rates, and reduced inflation. 

These savings will initially be relatively small, but will gather momentum over time and grow significantly to reduce debt-servicing costs by billions of rands and bring down the government’s debt load. 

In the researchers’ baseline scenario, debt-servicing costs as a percentage of GDP are projected to decline from 5.4% in 2025 to 5.3% in 2030 and 4.8% in 2035. 

This compares to debt-service costs that fall to 5.1% of GDP in 2029/30 and 4.2% of GDP in 2034/35 as the move to a lower inflation target reduces inflation, lowers short-term interest rates, strengthens the currency and supports a decline in real yields.

However, this will come with small short-term costs to the fiscus in the form of slightly slower GDP growth and elevated interest rates.