Opportunity knocking at South Africa’s door

South Africa has the perfect opportunity to lower its inflation target to 3% without much cost in terms of economic growth as pricing pressures have eased substantially over the past year. 

However, this window of opportunity is expected to close in the coming months as inflation is likely to pick up towards the end of 2025. 

As the effect of above-inflation electricity prices comes through and positive base effects roll out, pricing pressures will rise in the coming months. 

Inflation expectations also remain above the mooted 3% target, with the Reserve Bank’s Monetary Policy Committee (MPC) hoping its implicit targeting of a lower point will help drag expectations down. 

Reserve Bank Governor Lesetja Kganyago has pushed strongly for a lower inflation target in recent months, with the bank’s research department extolling the potential benefits. 

South Africa has averaged an annual headline inflation rate of 5% for the past ten years. Kganyago told the National School of Government that this is not a catastrophe. 

However, it is higher than 70% of countries and significantly above that of South Africa’s peers and developed economies. 

This is largely due to South Africa’s high and wide inflation target of 3% to 6%, with Kganyago explaining that the Reserve Bank has primarily targeted 5.9% implicitly as the country’s economy needed a looser monetary policy to drive growth.

Only recently, in 2018, did the bank shift towards the midpoint of the target range, with an implicit target of 4.5%. 

Now the bank wants to formally bring this down to 3%, with it shifting its implicit target towards the lower end of the range. 

This is to bring the country in line with its peers and make it more competitive globally. A lower target is generally expected to boost economic growth and assist in bringing interest rates lower over the long run. 

Now is the perfect time to do so, according to Kganyago. With inflation hovering around 3%, the cost of moving the target lower would be minimal. 

“As the saying goes, ‘opportunity knocks’, and over the past year that opportunity has come fast on the completion of the technical work on the optimal inflation target,” Kganyago said in his speech. 

“Actual inflation has eased to 3%, presenting us with a chance to achieve permanently lower inflation at low cost. This is what economists call ‘opportunistic disinflation’.”

Forcing the move lower

Kganyago explained that the Reserve Bank had to act quickly to ensure inflation expectations continue to trend lower and become anchored around 3%. 

While the formal shift to a new target may take sometime, the bank does not want inflation to pick up as then it would require tighter monetary policy to achive a lower target. 

This could have a negative impact on economic growth at a time when South Africa’s economy is extremely fragile and has grown at a mere 0.8% per year for the past decade. 

“Given the strong case for moving to a lower target at some point, it did not make sense to ignore this. But, we also did not have a new target,” Kganyago said. 

“We then laid the groundwork for the shift at our May MPC meeting by publishing a scenario with a 3% inflation objective.” 

“We also said in our statement that we considered this 3% scenario more attractive than the 4.5% baseline we typically forecast.”

Then, at the MPC’s July meeting, Kganyago announced the Reserve Bank’s preference for inflation to settle at 3% – the bottom end of its target range. 

He made it clear that this does not mean there will be higher interest rates in South Africa in the medium term, with the bank’s forecasts showing lower rates going forward than projections for a 4.5% target. 

This shows that Kganyago is aware the window is closing to move to a lower 3% inflation target, with economists warning that if inflation gets significantly higher than that target, bringing it back down could be painful. 

“We appreciate that there is much debate surrounding the lowering of the inflation target, with much discussion about the timing of the reduction,” Standard Bank chief economist Goolam Ballim told Daily Investor. 

“The politics of the moment may dictate that, when growth is weak, lowering the inflation target and the tighter monetary policy that comes with it, is not something that South Africa can afford.” 

There is a concern that if the inflation target is lowered, the Reserve Bank may need to keep interest rates elevated, potentially stifling economic growth in order to achieve the lower target. 

“However, I would be inclined to argue that we have a window of opportunity that is going to close soon for lowering the inflation target without much negative impact,” Ballim said.

With South Africa’s low inflation and declining expectations, very little has to change in terms of monetary policy to achieve the new target and maintain credibility. 

“If the target is calibrated to a 3% point, for instance, right now, the inflation expectations adjustment would be bearable.”

“If inflation expectations adjust quickly, it means the Reserve Bank will not need to employ a tighter monetary policy than otherwise to reach the target, thus minimising the impact on growth.”