Old Mutual: Sarb Committed to 3% Inflation Target After Rate Hold

• The South African Reserve Bank (Sarb) recently kept its policy rate unchanged at 7%, surprising markets that had anticipated a hike.
• Sarb remains committed to its 3% inflation target, a goal championed by Governor Lesetja Kganyago as part of his legacy.
• Global geopolitical events and elevated crude oil prices are contributing to inflationary pressures and impacting Sarb inflation expectations.
• Despite a recent rise in inflation expectations, the July inflation print was lower than expected at 4.3%, reducing the likelihood of a September rate hike.
• Old Mutual's strategist, Izak Odendaal, anticipates discussions shifting to ZA interest rate outlook for cuts in the new year, with any future cycle expected to be muted.

The South African Reserve Bank remains firmly committed to achieving its long-term 3% inflation target.

The South African Reserve Bank (Sarb) recently surprised financial markets by maintaining its policy rate at 7%, leaving the prime lending rate at 10.5%. This decision by the Monetary Policy Committee (MPC) came despite widespread expectations for a further increase, driven by rising inflation, geopolitical instability, and crude oil prices nearing $100 per barrel ahead of the meeting. Izak Odendaal, an investment strategist at Symmetry, Old Mutual's investment solutions arm, highlighted the market's astonishment at the Sarb policy rate unchanged stance.

Odendaal pointed to the complex global environment, specifically mentioning the US-Iran conflict and intermittent peace negotiations, as factors creating significant challenges for both investors and policymakers. Beyond elevated crude oil prices, a global shortage in refinery capacity has led to even higher costs for refined products such as diesel. While refined products typically command a premium of $20 to $30 per barrel over crude oil, this spread has recently widened dramatically, reaching up to $60 per barrel, exacerbating inflationary pressures.

Despite these immediate pressures, the South African Reserve Bank remains firmly committed to achieving its long-term 3% inflation target. This commitment is deeply rooted, with Governor Lesetja Kganyago having championed the push for a lower target, viewing its successful implementation as a crucial part of his legacy. Odendaal emphasized that successful inflation targeting does not imply hitting the target every single month or quarter. Instead, it signifies that if inflation deviates from the desired path, it will eventually return to the target, preventing businesses from continuously raising prices and workers from perpetually demanding higher wages.

The Sarb's proactive approach contrasts with some developed-market central banks, which were slower to react to the post-pandemic global surge in inflation during 2021 and 2022. The South African Reserve Bank and several other emerging-market central banks acted more swiftly, proving more effective in averting runaway inflation. While central banks have limited power over supply shocks like escalating oil prices, their crucial role lies in anchoring Sarb inflation expectations and guiding inflation back towards the target.

Central banks globally are currently grappling with a delicate balance: the risk of overreacting to what might be a temporary inflationary spike caused by geopolitical events versus the danger of allowing inflation to become deeply entrenched. In July, major central banks, including the European Central Bank, the Bank of England, the Bank of Canada, the Bank of Japan, and the US Federal Federal Reserve, all opted to keep their interest rates unchanged. However, Odendaal noted that the Sarb was in a comparatively advantageous position before the recent geopolitical tensions escalated, with its policy rate already elevated in real terms at the start of the year and inflation hovering near the 3% target.

He suggested that the 0.25 percentage point rate hike implemented in May might have been somewhat premature, implying that the current policy rate is approximately at its appropriate level. The widely observed Bureau for Economic Research (BER) survey of inflation expectations indicates a significant impact from recent global events on sentiment regarding future inflation. The one-year inflation expectation increased from 3.6% to 4.4%, while the five-year expectation rose from 3.6% to 4.1%, figures the South African Reserve Bank will closely monitor.

Looking ahead, the July inflation print registered at a lower-than-expected 4.3%, and the rand has shown some strengthening. These factors collectively reduce the probability of a rate increase at the upcoming September MPC meeting, although persistent fuel price pressures remain a concern. Odendaal anticipates that the discussion will likely shift towards potential rate cuts in the new year, suggesting that any future ZA interest rate outlook will involve a cycle that is muted compared to historical interest rate cycles.

Skepticism surrounding the achievability of a 3% inflation target is not new. Odendaal recalled that when the broader 3% to 6% inflation target was initially introduced in 2000, similar widespread doubts existed, particularly given the preceding three decades of persistent double-digit inflation. He maintains that Governor Kganyago's initiative to push for a lower target was indeed the correct strategic move, reinforcing the long-term commitment to the Old Mutual Sarb 3% inflation target.

This article signals the South African Reserve Bank's long-term commitment to a 3% inflation target, which provides a key economic indicator for lawyers advising on commercial contracts, financing agreements, and investment strategies. It impacts future interest rate expectations and the cost of capital for clients.

Source: Original reporting via Old Mutual's Symmetry