Rates at a crossroads

Next week, the South African Reserve Bank’s Monetary Policy Committee (MPC) will meet to determine the appropriate level of the central bank’s policy rate, commonly known as the repo rate, given the current macroeconomic environment and the outlook for the months ahead. At its previous meeting on 28 May, the committee voted four to two to increase the repo rate from 6.75% to 7.00%. Higher interest rates were considered appropriate as inflation began to rise in response to the increase in global energy prices brought about by the conflict between the United States and Iran.

At the time, Reserve Bank Governor Lesetja Kganyago was clear about both the role and the limitations of monetary policy. Interest rates are largely powerless against the initial impact of an external price shock. They cannot increase the supply of oil, reverse geopolitical developments or immediately lower global energy prices.

They are, nevertheless, an important tool in preventing those initial pressures from spreading more broadly through the economy. By acting early, the Reserve Bank aims to contain second-round inflation effects and ensure that expectations of higher inflation do not become entrenched.

The Governor was equally clear about the division of responsibility between monetary and fiscal policy. The Reserve Bank’s mandate is to protect the internal and external value of the rand by maintaining price stability. Encouraging stronger economic growth, within the constraints of the National Budget, remains the responsibility of the fiscal authorities.

The MPC will now consider what has changed since its previous meeting and whether those developments require a further policy response.

Before the committee’s statement is delivered on Thursday, it will have the latest consumer price inflation figures to consider. Statistics South Africa is expected to publish the June data on Wednesday, with headline inflation forecast to remain at, or slightly above, the 4.5% year-on-year rate recorded in May.

With the Reserve Bank targeting inflation of 3.0%, a reading at that level would strengthen the argument for tighter monetary policy.

The latest quarterly inflation expectations survey, published at the end of June, adds to the pressure. Respondents expect inflation to average 4.4% in 2026, 4.2% in 2027 and 3.9% in 2028.

Although these forecasts point to inflation easing gradually, expectations remain well above the 3.0% target throughout the period. This deterioration is likely to concern the MPC, as expectations can influence wage negotiations, business pricing decisions and household behaviour.

Once businesses and consumers begin planning around persistently higher inflation, it becomes more difficult and more costly for the central bank to bring price growth under control.

Central banks therefore place considerable importance on the credibility of their targets. The US Federal Reserve’s leadership has been clear that its inflation target is 2.0%, while Governor Kganyago has been equally firm that South Africa’s target is 3.0%.

There is always an acknowledgement that interest rates are a blunt tool when dealing with external price shocks. Even so, they remain the primary instrument available to central banks to manage inflation expectations and limit the risk of temporary pressures becoming permanent.

While the inflation data and expectations survey may favour a further increase, other developments could encourage the MPC to pause.

Although the US-Iran conflict has continued, oil prices are currently lower than they were two months ago. Predicting how the conflict will develop, and what that may mean for global energy prices, remains extremely difficult. Even so, the recent moderation could allow the Reserve Bank to lower the US$91-per-barrel oil-price assumption used in its previous forecasts.

The rand’s recent strength may also provide the MPC with a more favourable starting point when it updates its Quarterly Projection Model. A stronger currency helps to reduce the local cost of imported fuel and other goods, limiting the extent to which international price pressures are passed on to South African consumers.

Taken together, a stronger rand and a lower oil-price assumption could improve the Reserve Bank’s inflation forecasts over the next two years. Should the projected path of inflation move closer to the 3.0% target, the committee may be more hesitant to increase rates again.

Developments in the United States could provide further room for patience. The US Federal Reserve has not increased interest rates in response to the conflict and based on the latest inflation data, may have no immediate need to do so.

A rise in US interest rates without a corresponding increase in South Africa could place pressure on the rand by narrowing the interest-rate differential between the two countries. If the Federal Reserve remains on hold, the MPC may not need to increase the repo rate simply to protect the currency.

The MPC acted at its previous meeting to get ahead of the inflation curve. Rather than waiting until second-round effects had become embedded, it chose to send a clear signal that it remained committed to containing inflation and protecting the credibility of its target.

The question now is whether another increase is needed to reinforce that message, or whether the committee has already done enough for the time being.

A further increase could strengthen confidence in the Reserve Bank’s commitment to the 3.0% target. On the other hand, monetary policy works with a lag, and the full effect of May’s decision has yet to filter through the economy. Raising rates again too quickly could place additional pressure on households and businesses before the impact of the previous move is fully understood.

In truth, the decision could go either way. A strong case could be made for another increase based on elevated inflation and deteriorating expectations. An equally credible argument could be made for leaving the repo rate unchanged while the committee waits for more information.

The MPC may ultimately choose to adopt a wait-and-see approach and reconsider the variables once more data is available at its next meeting on 23 September.

This is not one to bet the farm on, but a pause followed by another assessment in September may be the more reasonable small wager.