The day after the SA Reserve Bank announced its decision to go it alone on the lowering of the inflation target by changing its “preference” to 3% from 4.5%, finance minister Enoch Godongwana said he had no plans to announce the change, and that such a change would follow the “established” consultation process and “not unilateral announcements that pre-empt legitimate policy deliberation.”
While this issue remains unsettled, it would probably be too painful for the economy if this policy were to be rolled back now. Though inflation has accelerated since the end-July monetary policy committee (MPC) meeting at which the Bank in effect adjusted the target, economists’ long-term inflation forecasts have dropped to a record low of about 4%, reflecting expectations of a structural move lower in inflation. Financial markets have also moved to reflect the same, a crucial factor that should influence discussion when policymakers decide the way forward.
There are signs that the market is now poised for a lower inflation world. Interest rates have moderated, consistent with lower inflation expectations. The 10-year government bond yield is down 0.7 of a percentage point since the Bank first put the new inflation target on the table in May, and SA bonds have performed better than peers over the period. The government is borrowing almost a percentage point lower now than where it was before, at levels last seen in 2022.
Delaying this announcement would reduce the credibility of a policy that is, in fact, already being implemented.
Economists forecast that the Bank will lower the repo rate to 6.5% by the end of 2026. This compares with the expectation that the repo would not be cut below 7% before the target change. The average rate charged to local companies for five-year debt, as reflected in swap rates, has declined by 0.4 of a percentage point since the May meeting. This is consistent with the more dovish interest rate outlook.
This lowering of borrowing costs for every creditor from households to corporates and on to the state would be unwound if lowering the target were abandoned, which would be a cost to the economy. We have long debated the costs of adopting a lower inflation target, but policymakers must now add to their consideration the costs associated with raising the inflation target back to 4.5% from 3%, which can now be partially quantified. The cabinet and the National Treasury must take this into account when deciding the way forward for the inflation targeting debate.
Godongwana said in his statement that he would not be announcing a change in target at the October medium-term budget policy statement. Delaying this announcement would reduce the credibility of a policy that is, in fact, already being implemented. It would make the job of anchoring inflation harder for the Bank and more expensive for the economy. Such a delay would not serve anyone.
The failure of the Treasury and Bank to align on this issue, and the ventilation of this disagreement in the open, is deeply concerning. It reveals a previously unknown fissure between the Treasury and Reserve Bank.
The longer this discord between the Bank and Treasury — and by extension the cabinet — remains, the more worried markets will be about the monetary policy credibility that has long been a bulwark for SA’s economy and macroeconomic stability. That this is happening as US President Donald Trump launches an assault on the independence of the Federal Reserve, the most important central bank in the world, does nothing for the optics of our situation.
Going back on the inflation target would cost SA in higher yields in the short term and potentially erode policy credibility in the longer term. Whether by design or happenstance, the Bank has painted the economy into a corner with its 3% inflation target. It is probably too late to turn back now.
• Lijane is global markets strategist at Standard Bank CIB.
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