Inflation-targeting on top bank’s radar

The Reserve Bank has made it clear it wants to see inflation expectations anchored at the 4.5% midpoint of its target range, but it isn’t set to change its 3%-6% target range any time soon. SA adopted inflation targeting as the monetary framework in February 2000. The Reserve Bank achieves its constitutional mandate of protecting the value of the rand by limiting inflation to within the 3%-6% target range, which originally reflected the average inflation experienced in the country’s trading partners. Inflation, if not kept in check, can erode savings, inhibit growth, discourage investment, cause capital flight and cause social and political unrest. It was accepted by the Bank and the market that the goal was to keep inflation below the upper end of the 6% target – anything above that would likely see a rate hike and anything below it would signal room to cut rates. But in the last two years, there has been a distinct change in the Bank’s rhetoric. Monetary policy committee (MPC) members have consistently communicated the desire to shift inflation expectations from the 6% upper end of the target band towards the 4.5% midpoint. In September 2017, the Bank changed from using the core model to using the quarterly projection model (QPM) – which explicitly anchored inflation at 4.5%. Momentum Investments economist Sanisha Packirisamy said there is a case to be made that with technological advances, changes in productivity and Chinese disinflation that this range of inflation outcomes is lower for SA’s trading partners. Investec chief economist Annabel Bishop said: “While our key trading partners are around the 3% mark, SA tends to ride higher at 5.5% or 6%”. According to the Bank, having inflation anchored in the middle of the 3%-6% range allows for greater monetary policy flexibility, which makes it easier to look through inflation shocks if the underlying inflation was not already almost outside the target. In fact, SA is one of very few economies with a target range. “To manage the risks to inflation you must be at the midpoint, because if you are at the midpoint should you experience a shock, you don’t have to react in an immediate manner because you have got flexibility within the target,” the Bank's governor Lesetja Kganyago said. Anchoring inflation expectations at 4.5% should allow for a more stable and lower inflation and interest rate profile, relative to the past years, Packirisamy said. For example, in the event of an externally-driven food price shock or currency blowout, the Bank would have more room to manoeuvre. However, if inflation was stubbornly anchored at the top end of the target range, this would leave the Bank little choice but to increase interest rates further to defend its inflation targeting mandate, which would have a negative impact on growth and employment, she said. While the Bank has made it clear that it would prefer inflation at 4.5%, it has no immediate plans to change its inflation target range of 3%-6% to a single target of 4.5%, deputy governor Daniel Mminele said earlier in 2019. This November rate hike, the first in two years, sent a clear message the Bank is looking to manage inflation down towards 4.5%.