How rising inflation affects interest rates in South Africa
June's consumer price index (CPI) rose to 3%, up from May's 2.8%, marking the first time in three months that inflation has returned to within the South African Reserve Bank's (SARB) 3% to 6% target range. Despite this small increase, inflation remains low by historical standards and well below the 5.2% seen a year ago.
Old Mutual chief economist Johann Els said that while food prices, particularly red meat, were a touch higher than expected, partly due to the effects of foot-and-mouth disease, most categories remained muted. 'Consumer goods inflation is still very subdued,' he said, with clothing, furniture, and appliances still in negative territory year-on-year and core inflation slipping to 2.9%.
This paints a picture of an economy with weak pricing pressure, which Els argued justifies a further 0.25 percentage point cut to interest rates at the Monetary Policy Committee meeting next week.
Els said government has a 'window of opportunity' to announce a reduced 3% target for inflation. SARB governor Lesetja Kganyago has been pushing for a lower inflation target, although this will require a National Treasury policy change.
'If we miss this window of opportunity over the next few months, it's going to be more difficult for the Reserve Bank to get inflation down sustainably to 3%' as it will start drifting upwards into next year, he says.
Els said that inflation is expected to rise moderately through the rest of the year, approaching 4% by December. 'If we miss this window, it will become more difficult for the Reserve Bank to sustainably bring inflation closer to 3% once it starts drifting upwards again.'
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Another view is that repo rate decisions are no longer about the midpoint of the target band, but rather about the proposed new target of 3%. With a lower target in mind, it may not make sense to cut the repo rate just yet. I think the Reserve Bank has already made a strong case for the benefits of a lower target. Their models show that because inflation is already low, the cost of moving to a lower target is minimal. They don't believe interest rates will need to stay high for long, nor that much economic growth will be sacrificed in the process. Video Player is loading. Play Video Play Unmute Current Time 0:00 / Duration -:- Loaded : 0% Stream Type LIVE Seek to live, currently behind live LIVE Remaining Time - 0:00 This is a modal window. Beginning of dialog window. Escape will cancel and close the window. Text Color White Black Red Green Blue Yellow Magenta Cyan Transparency Opaque Semi-Transparent Background Color Black White Red Green Blue Yellow Magenta Cyan Transparency Opaque Semi-Transparent Transparent Window Color Black White Red Green Blue Yellow Magenta Cyan Transparency Transparent Semi-Transparent Opaque Font Size 50% 75% 100% 125% 150% 175% 200% 300% 400% Text Edge Style None Raised Depressed Uniform Dropshadow Font Family Proportional Sans-Serif Monospace Sans-Serif Proportional Serif Monospace Serif Casual Script Small Caps Reset restore all settings to the default values Done Close Modal Dialog End of dialog window. Advertisement Next Stay Close ✕ Ad loading However, their whole story rests on several assumptions, and recent research by Codera Analytics shows that there are many factors to consider. One question is how quickly inflation expectations can be anchored to the lower target. It's no use having a lower target if unions continue to base wage demands on historically higher inflation rates. Another question is whether fiscal policy can support the lower target. If public finances deteriorate, long-term interest rates on government debt will rise, and stimulatory fiscal policy could increase inflation. A lower target requires fiscal discipline. Lastly, the government as a price setter must also buy into the lower target. More than 30% of the CPI basket consists of administered prices, which in recent years have increased at rates far above the headline inflation rate. To achieve a lower average inflation rate while, for example, electricity tariffs, rates and taxes are rising steeply, those parts of the economy where prices are flexible will take interest rate strain at a high cost for the private sector. I don't think the MPC's decision will be driven by the idea of a new lower target. They need political buy-in and the inflation targets set for the next Budget cycle are at the 4.5% mid-point. But I also think that the decision about the target cannot be delayed much longer. Uncertainty does nothing to help manage expectations. Waldo Krugell is a Professor of Economics, North-West University, Potchefstroom. Image: Supplied Waldo Krugell is a Professor of Economics, North-West University, Potchefstroom. *** The views expressed here do not necessarily represent those of Independent Media or IOL BUSINESS REPORT
