Lowering the country’s inflation target could have positive effects for monetary policy, with inflation and the repo rate increasing slower.
The Reserve Bank governor has been talking about lowering the inflation target for a while now and economists expect that the minister of finance, Enoch Godongwana, could announce it during his Budget 3.0 speech in parliament on Wednesday.
The South African Reserve Bank (Sarb) has the constitutional mandate to protect the value of the rand by keeping inflation low and steady, and uses interest rates to influence the level of inflation. To protect the value of the rand, the Sarb currently uses inflation targeting to maintain consumer price inflation between 3% and 6%.
Lesetja Kganyago, governor of the Sarb, said in a speech in October last year that he would like South Africa’s inflation target to be lower than the current target band of 3% to 6%, as the country was able to lower inflation to 4.5% without too much pain or cost.
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Targeting inflation in South Africa
The country implemented inflation targeting nearly a quarter of a century ago in 2000. “Looking back, the framework has been generally successful. Both inflation and interest rates have been lower than they were before inflation targeting.
“Inflation has also been within the 3−6% target range, on average. However, this average has been on the high side of the target range. Since 2000, using the ‘targeted inflation’ measure, it has averaged 5.85%.”
He acknowledged that the country missed the target quite often, almost exclusively to the upside. “We have been above the 6% upper bound of the target nearly 40% of the time, compared to only 1% of outcomes below the 3% lower bound.”
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Inflation targeting could have positive effects
Bianca Botes, a forex expert at Citadel Global, says the Sarb and National Treasury’s move to lower the country’s inflation target could have positive effects on monetary policy, interest rates, and the strength of the rand, but it will need to be handled with care to avoid negative consequences for the local investment climate.
She also points out that Kganyago recently argued for a lower inflation goal, noting that South Africa’s inflation target is relatively high compared to other emerging markets and advanced economies.
“While the move would likely benefit the broader economy, consumers may see slower increases in prices, as well as slower wage growth. Businesses, on the other hand, may benefit from slower wage growth and greater economic stability,” she says.
“The move would align South Africa with global peers who maintain lower inflation goals. This has already boosted the rand to its strongest level against the dollar in the past two months.”
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What will inflation targeting mean for business and investors?
Botes says it is likely that SA will see very careful adjustments to interest rates, further strengthening of the rand, and a stabilising effect on the economy. However, if this is not handled very carefully, it could dampen infrastructure investments in particular.
“A lower inflation target would likely influence the Sarb’s approach to interest rates. While a stricter target might suggest tighter monetary policy to keep inflation low, current analysis suggests that the Sarb may not necessarily increase interest rates aggressively.
“Instead, the central bank might adopt a more cautious stance on rate hikes and cuts, focusing on maintaining inflation within the new, narrower target. This could mean more gradual adjustments in interest rates, aiming to balance inflation control with economic growth and employment objectives.”
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How will a change in inflation targeting affect the rand?
Botes says the rand’s value is closely linked to inflation and interest rate dynamics.
“A credible commitment to a lower inflation target could strengthen the rand by boosting investor confidence and improving returns on rand-denominated assets. This was evidenced recently when the rand surged upon market optimism about improved monetary policy credibility and economic stability.”
Turning to the broader economic implications of lowered inflation, Botes says lower inflation targets tend to reduce inflation expectations, which can moderate wage and price increases, helping to stabilise the economy.
“Research into South Africa’s experience with moving the inflation midpoint to 4.5% shows that such shifts can be achieved without sacrificing Gross Domestic Product (GDP) growth or increasing unemployment, provided the central bank maintains clear communication and credibility.
“This suggests that a further reduction in the inflation target could be managed with minimal economic disruption.”
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But beware the unintended consequences of a lower inflation target on investment growth
However, Botes warns of the unintended consequences of a lower inflation target on investment growth. “While this move could lead to more cautious interest rate policies and strengthen the rand, it requires balancing inflation control with growth and investment needs.
“The ultimate impact will depend on the clarity of communication, policy credibility and the broader economic environment.”
This comes as the Sarb warned that even a single-point inflation target requires careful calibration to avoid unintended consequences, such as restricting infrastructure investment or economic activity. “The flexibility inherent in the current target range allows for temporary deviations, which might be constrained under a tighter target regime,” Botes warns.
The inflation target is set by the minister of finance in consultation with Kganyago and the Sarb independently implements monetary policy, primarily through controlling short-term interest rates to keep inflation within this range.
Botes says the Monetary Policy Committee (MPC) of the Sarb has emphasised aiming for the midpoint of 4.5% since 2017, reflecting a more precise inflation goal within the range.
