SA central bank governor urges lower inflation target

South Africa can keep benchmark interest rates low by shifting its inflation-targeting framework to a reduced, single-point target from the current 3%-6% range, central bank Governor Lesetja Kganyago said.

“If we want to keep interest rates low, the most important thing we can do is to lower the inflation target,” Kganyago said Wednesday in an online address to mark his appointment as an honorary professor of economics at the University of Stellenbosch.

A single-point target of 3% or 4%, with an error range of about one percentage point on either side, would help to better anchor inflation expectations, prevent any uncertainty associated with a broad range and boost the country’s competitiveness relative to its peers, he said.

“I take the view that 3% would be a good point target,” Kganyago said.

South Africa’s inflation-targeting framework is set to be examined as part of a macroeconomic review by the National Treasury, he said. Formal discussions about lowering the target have yet to take place with newly appointed Finance Minister Enoch Godongwana.

The target, first announced in 2000, is set by the finance minister in consultation with the central bank.

‘Major policy mistake’

The failure of policy makers to stick to plans to lower the target to 3%-5% by 2004 and then further down to 2%-4% was a “major policy mistake” as it entrenched higher inflation and higher inflation expectations, he said. “The target range of 3%–6% was eventually interpreted as a target point of 5.99%, resulting in nominal interest rates several percentage points higher than they might have been.”

While lowering the target could initially result in a less accommodative monetary policy stance, its long-term benefits would outweigh any pain caused at the onset, he said. It would be easier and cheaper to make the change with acceptance from those who set administered prices such as electricity and water, he said.

The bank’s monetary policy committee prefers to anchor price-growth expectations close to the 4.5% midpoint of its range, though that isn’t optimal, Kganyago said. While the annual rate of increase in consumer prices fell to a 16-year low of 3.3% in 2020, partly due to coronavirus-induced shocks, South Africa remained a high-inflation economy with a ranking of 88 out of 154 countries, the central bank said in April.

“We should really be benchmarking our performance to the high achievers in our class, not contenting ourselves with doing somewhat worse than average,” he said.

The central bank risks falling behind some of its emerging-market peers on normalizing monetary policy after it turned less hawkish at its July meeting, days after deadly riots that erupted in the eastern KwaZulu-Natal province and the commercial hub of Gauteng disrupted supply chains and weighed on economic activity. Still, inflation that’s set to remain well-anchored close to the midpoint of the target range could allow the bank to continue supporting a South African economy that is seen contracting in the third quarter.

The committee cut the key rate by 300 basis points from January to July last year to buffer the economy against the global fallout from the pandemic and the impact of local lockdown restrictions. Since the start of this year, none of the five MPC members have voted for further easing and the panel has consistently indicated that the next move will be up.

The central bank’s quarterly projection, which the MPC uses as a guide, implies one 25-basis-point increase from the current 3.5% by year-end. Forward-rate agreements, used to speculate on borrowing costs, starting in four months show traders see a more-than-90% chance of a quarter-point increase this year, while economists in a Bloomberg survey are only predicting policy tightening from the first quarter of 2022.

The MPC is due to announce its next interest-rate decision on September 23.