This is how SA managed to ride the postpandemic inflation waves

Much is to be learnt from the experience of the period since the Covid-19 outbreak in early 2020

TSA he ’post-Covid-19 s inflation peaked economic at 7.8% in environment has been extraordinarily challenging, not least due to the prolonged surge in global inflation. July 2022, rising from an average of 3.3% in 2020. Since returning to the 3%-6% target range set by the Reserve Bank, headline inflation is within reach of the midpoint but continues to exhibit significant monthly volatility.

Our forecast now is for a gradual decline to about 4.5% in the absence of any domestic or international shocks.

How did we get back to something approximating inflation normality, and what lessons can we take from the experience of the period since the pandemic outbreak in early 2020?

Looking back, the global economic recovery was generally well under way by the beginning of 2021, including in SA, but like elsewhere was far from complete. The economy had largely reopened, yet few if any sectors had recovered to their prepandemic levels of output.

By mid-2021, strong demand for goods and constrained supply chains pushed producer prices higher globally. SA’s trading partners’ wholesale prices reversed aggressively from deflation to 9.3% over two quarters.

However, even with deflation itself clearly in the rear-view mirror, central banks largely expected inflation to reverse as vaccines were rolled out and supply and demand balances readjusted to a lower-price equilibrium.

The Bank’s monetary policy committee (MPC) remained wary of this “transitory” view though, with strong producer price inflation prompting the committee to flag future upside risks to the inflation trajectory already in May 2021. This assessment, the first of its kind since the pandemic began, signalled future policy normalisation, but not yet lift-off.

Despite the growth rebound in 2021, a fuller recovery looked remote, and despite sharp rises in global food price inflation, local food prices were stable. Inflation expectations had also tracked inflation lower, suggesting a modest and gradual rise in core inflation over the forecast horizon.

In this period, the MPC exploited the flexibility of the policy framework to communicate a deteriorating risk profile, but also to look through the temporary upside shocks. The committee emphasised that the era of ultra-low interest rates would not last forever, that global inflation would spill over into SA prices more strongly, and that “normalisation” would need to occur despite uncertainty over its timing.

This balancing act of supporting the economic recovery despite rising inflationary risks continued until November 2021, when the inflation risks flagged earlier in the year began to materialise. Inflation jumped from 5% to 5.5% in October, with significant additional upside risks increasingly apparent.

Alongside the climb in inflation, it also became clear that SA’s sustainable pace of growth was falling. The rollout of vaccines had progressed at a faster pace, but underlying growth trends were soft. Social unrest in the second half of 2021 and falling energy availability suggested both near and longer-term constraints to growth.

Scarring effects from the various economic shocks dragged on investment and job creation, and despite rising demand for credit it was not clear how much more growth would come via the interest rate channel. In this period, even with a large output gap, the downward pull on inflation was hard to see, leading the committee to consider whether even modest demand would risk (once again) pushing inflation too high.

Policy normalisation was now needed to raise real rates closer to a neutral level that on balance was itself rising. This was communicated to the public and markets to shape inflation expectations, but without prompting aggressive deleveraging.

A series of hikes of 25 basis points (bps) occurred in November 2021, January 2022 and March 2022, with faster tightening coming after the Russian invasion of Ukraine translated to higher food and fuel inflation. Within a year, policy rates increased by a cumulative 350bps, and then another 125bps over the January 2023, March 2023 and May 2023 meetings, pausing at 8.25%.

Policy was finally deemed restrictive, with current and ex-ante real repo rates finally pushing past their neutral levels for the first time since the onset of the pandemic.

While the committee analysed the merits of front-loading rates, the materiality of the inflation risk assessment and what level of rates the economy could bear, the need to normalise policy was clear and every member voted to hike rates in every meeting between March 2022 and May 2023.

The early November 2021 lift-off and subsequent rate hikes, which gradually reversed the extraordinary loose policy settings in place since early 2020, were helpful in dampening inflation expectations and helped moderate the rate cycle to come.

The bottom-to-top swing in rates was relatively modest, compared either with the trajectory seen in many other economies or in terms of SA’s own history. Core inflation rose just 2.7 percentage points during the surge, far below that of many peers.

Stepping back, we see that compared with the pre-inflation targeting period, price shocks have generated far lower price peaks, inflation has reverted to target faster and at lower interest rates. The introduction of a 4.5% midpoint target built much-needed space before the crisis hit.

For now, the main priority is to get inflation back to target, but ambition is also warranted. The Bank’s high policy credibility enables moving to a better and lower inflation target, close to those of our trading partners, and generating a wide range of economic gains.

A lower inflation rate and premium would help set off a virtuous cycle of currency stability, lower long-term borrowing costs and stronger growth and investment, improving welfare of all households — especially those at the bottom end of the income distribution.