South Africa: Reserve Bank warns that Ukraine war poses risk to inflation

While the South African Reserve Bank officially targets price growth in a band of 3% to 6%, its monetary policy committee prefers to anchor expectations close to the midpoint of the range. A survey showed inflation assumptions over the next two years increased to 5% in the first quarter, from 4.7% in the final three months of 2021, raising the prospect of “more enduring” second-round effects on prices, it said Tuesday in its bi-annual Monetary Policy Review.

The bank doesn’t respond to short-term price shocks. Instead, its policy making seeks to address the wider second-round effects of higher prices, such as on transport and food costs and that could feed into wage setting.

The monetary policy committee raised the bank’s benchmark rate by a cumulative 75 basis points to 4.25% since November to tame rising inflation, unwinding some of 2020’s extraordinary monetary policy stimulus that was aimed at shoring up an economy ravaged by the coronavirus pandemic. Despite those increases, the real interest rate – the difference between the rate of price growth and the key interest rate – “has become more accommodative as inflation has risen faster” and is highly stimulatory, it said.

While the central bank plans to normalise interest rates, in line with developed and peer economies, its stance “is currently expected to remain accommodative and supportive of the economic recovery,” it said.

At its last monetary policy committee meeting in March, three panellists voted for a quarter-point increase, with the remaining two preferring a 50 basis-point hike. The vote split was viewed as particularly hawkish by markets, especially as the benchmark rate hasn’t been raised by 50 basis points at a single meeting in more than six years.

The central bank also said it aims to introduce a new monetary policy implementation framework this year, switching to a surplus system from the deficit mechanism that’s been in place since 1998.

The change means commercial banks will be allowed to build a surplus of reserves, some of which can be placed at the Reserve Bank and earn the policy rate – a shift from the current system, whereby the central bank engineers a shortage of reserves and lends the missing funds to commercial banks at the benchmark interest rate.

New framework

The new framework, which should take about three months to transition to and will follow a pre-announced path, will improve interest-rate control and avoid some of the distortions and expenses associated with the deficit system, the Reserve Bank said.

It will also come after shortages have now fallen to about R30 billion to R35 billion, compared with typical pre-coronavirus deficits of R56 billion. Those reduced shortages, coupled with commercial banks borrowing more than needed to offset the deficit at the Reserve Bank’s Wednesday repo auctions, have led to the interbank market generally ending the day with a “substantial surplus in contrast with the pre-crisis norm where excess reserves were nearly zero,” according to the central bank.

The average end-of-day position has been R5.3 billion over the past six months, up from R161 million in 2019, it said.

Reserve holdings of banks in the new framework will be guided by caps that prevent lenders from hoarding liquidity and thus help to maintain the interbank money market, similar to the “tiered floor” system used by the Reserve Bank of New Zealand and the Norges Bank, the central bank said.