At May’s monetary policy committee meeting, the Reserve Bank stepped up its four-year campaign for a 3% inflation target, publishing a 3% scenario showing it would lead to lower interest rates without causing too much pain to the economy.
Last week, it took an even bolder step, making it clear that it now “preferred” inflation to settle at 3% and had therefore “decided to aim for the bottom of our inflation target range of 3%-6%”.
Governor Lesetja Kganyago has long argued that lower inflation begets lower interest rates. The Bank has put a strong case for the lower target in a number of research papers and at a joint conference with Treasury earlier this year.
SA’s inflation rate and its inflation target are higher than those of its major trading partners and many emerging market peers, putting pressure on the exchange rate and keeping SA’s economy uncompetitive.
The Bank’s models show the benefits for the economy and the public finances of lower rates. With SA’s consumer price inflation rate having traded in a narrow band of 2.7%-3.2% for the past nine months, a lower target could in theory be achieved without too much economic pain — and the Bank has been ultrakeen to take advantage of this opportunity.
The market liked the idea too, with many expecting an imminent move to a lower target, likely in October’s medium-term budget. And at least in theory, the Bank could do just as it did in 2017 when it made it clear that it was aiming for the 4.5% midpoint of the target range, and that it would instead target the bottom.
However, it has long been the practice that the governor consults with the finance minister on the target. Finance minister Enoch Godongwana and the Treasury had repeatedly said that they were still working on it.
Whether they were ever going to decide to lower the target is not clear. But the Bank clearly felt it could not wait forever — and that it was within its rights to pick a different piece of the existing target range, as it did on Thursday.
In the event, Godongwana retaliated with an aggressive statement on Friday afternoon, saying he had no plans to announce a new 3% target at the medium-term budget and emphasising that any adjustments to SA’s inflation targeting framework would follow the established consultation process.
This meant, said the minister, “comprehensive consultation between the National Treasury, the Reserve Bank, cabinet and the relevant stakeholders — not unilateral announcements that pre-empt policy deliberation”.
That has put question marks over the politics of the Bank’s move, raising concerns about the Treasury and the Bank being at odds. The economics is also a question. The Bank’s forecasts show that a 3% preference will bring inflation and interest rates down further and more durably than a 4.5% preference, without economic growth taking too much of a hit.
Indeed, its models indicate we could see five more interest rate cuts with 3%, but probably no more cuts with 4.5%. SA would surely welcome that. A permanently lower inflation trend would also be extremely welcome and a social good. Nobody loves steep increases in the cost of living, and inflation is a tax on the poor in particular.
But as always with economists, views are at odds and not everyone agrees with the Bank’s scenarios. It is assumed that inflation expectations will rapidly decline towards the new target, helping to reduce the inflation rate, but some query whether it is being too optimistic.
It is assumed the new target will also help to support the rand exchange rate. Not everyone is convinced, especially given uncertainty about the global outlook and the US Federal Reserve’s interest rate intentions.
If the Bank proves right — and we hope it does — the finance minister and the Treasury could be persuaded to formalise a lower target sometime in the next few years. If it is wrong, the politics and the economics could get tough.
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