Kganyago ‘locks in’ on 3% inflation target 

Lesetja Kganyago wants an inflation target of 3%, and, by the looks of things, the South African Reserve Bank (SARB) governor is going to get it. 

After cutting interest rates to their lowest level in more than two years on Thursday – to 7.25% – the monetary policy committee (MPC) sketched out a scenario that will result in the biggest revamp to the country’s inflation targeting regime since February 2000. 

It was then that the National Treasury, under finance minister Trevor Manuel, mandated the late governor Tito Mboweni to keep inflation within a range of 3%-6%, though as time wore on the emphasis increasingly shifted towards the 4.5% midpoint.  

“The governor has now all but confirmed that a 3% target is under serious consideration,” Reza Ismail, the head of bonds at Prescient Investment Management, tells Currency. The government hasn’t yet made a final decision on what the new target will be. 

The bond market is already responding to the shift. Yields on 10-year bonds fell to their lowest level in four months after the MPC’s announcement – a move more commonly seen in short-term debts that are typically more sensitive to rate cuts. The rand, meanwhile, strengthened 1% against the dollar. This suggests investors are confident that governor Kganyago and his team will not only secure a lower inflation target, but also keep inflation anchored at that level. 

The yield curve, which maps interest rates across government bond maturities, has “factored in lower equilibrium inflation expectations”, Ismail says. “It shows confidence in the SARB’s ability to anchor inflation.” 

A lower inflation target would help stabilise the rand, which also forms part of the SARB’s mandate, he says. This is because high inflation erodes the value of an investment, so if the US runs at 2%, and South Africa at 4.5%, the rand would theoretically weaken by 2.5% a year over the long term. 

With inflation registering 2.8% in April, 2.7% in March and the SARB forecasting it to average 3.2% this year (an improvement from a previous estimate of 3.6%), there is now scope to change the target without affecting the economy too much, Kganyago said. Lower global oil prices and the rand’s unexpected resilience in the face of global uncertainty are helping to keep inflation “well contained”. 

“For some years now, internal and external analysis has shown that our inflation target is too high and too wide,” he said. The SARB and Treasury “have engaged extensively on this issue, and technical work is at an advanced stage. Now that inflation has slowed, we have a chance to lock in lower inflation at low cost.” 

Translated, this means that while interest rate cuts may not be as deep as they could’ve been under an inflation-targeting framework of 4.5% in the immediate term, a 3% target would eventually result in a structurally low inflation environment and lower interest rates. Ultimately, it means after an initial slowdown, economic growth should accelerate. 

But even under a 3% scenario, the SARB’s models indicate there still would’ve been room for a cut, with the benchmark rate moving steadily lower to just under 6% by the end of 2026, rather than hovering around 7%, Kganyago said. 

Striking a balance

There’s always the risk that the shift to a lower inflation-targeting regime will come under fire from labour unions, which protested against the policy when it was first introduced, claiming it hurts the poor and deepens inequality, because of higher borrowing costs. 

The central bank, however, in a paper accompanying the MPC statement, cited studies showing the opposite, as low-income households depend on social grants, and that they benefit when their purchasing power improves. For working-class households in the formal sector, the adjustment will only be temporary and lower inflation will increase their real income over time. 

The main impediments to economic growth, job creation and poverty alleviation have, in any case, been proven to be double-digit price increases in government services, power shortages, broken ports and freight railway networks, corruption and over-regulation. Monetary policy alone cannot fix the economy. 

In the working paper the MPC released with the decision on rates, called “Less Risk and More Reward: Revising South Africa’s Inflation Target”, it argues that a 3% target strikes a useful balance: it’s low enough to anchor expectations and support currency stability, but high enough to avoid the risks of hitting the zero lower bound – where interest rates can’t go lower to stimulate the economy. 

It also allows room for necessary price shifts in the economy, like wage adjustments and sector-specific changes, without causing major disruptions when interest rates move. It is possible that by the end of 2027, South Africa could achieve inflation of 3%, and, in so doing, a potential repo rate of about 5%. 

The cut to the MPC’s benchmark interest rate takes the prime rate (which is used to price what consumers pay on their loans) to 10.75% from 11%. That’s a saving of about R170 a month on a R1m house financed over 20 years, and about R41,000 over the life of the loan. 

Yields on 20-year bonds declined 17 basis points (bp) to 11.49%, while those on 10-year securities dropped 15bp to 10.16%, the lowest since mid-January. Five-year bond yields fell 11bp to 8.65%, according to data compiled by Trading Economics. The rand gained, going from R17.97/$ to R17.80.

“Lower rates only happen if people ‘buy in’ to the new target and inflation expectations, wage-setting, and all other inflation-movers eventually push (or keep) actual inflation lower,” Lisette IJssel de Schepper and Shannon Bold of the Bureau for Economic Research (BER) say in a note. 

“This is, of course, easier said than done in an environment where we have a history of double-digit administrative price increases and continued above-inflation public sector wage settlements,” the economists say. “Still, getting to lower inflation in such an environment is not impossible.” 

Another 25bp cut may come in July, according to the BER, with the MPC indicating that the “terminal rate” is about 7%. “However, this is if the exchange rate (and Trump) ‘behaves’ and we see inflation expectations trail further down,” say De Schepper and Bold. 

_{Top image: Reserve Bank governor Lesetja Kganyago. Picture: Per-Anders Pettersson/Getty Images.}