The South African Reserve Bank (SARB) left interest rates unchanged yesterday, but signaled gradual cuts in future as inflation is expected to subside.

SARB kept its benchmark repo rate 6.75%, a move that means that commercial lenders will also keep the benchmark prime lending rate unchanged at 10.25%.

Two members of the Monetary Policy Committee, chaired by SARB Governor Lesetja Kganyago, favoured a cut of 25 basis points, while four preferred a hold.

In November last year, SARB cut the repo rate -- the rate at which it lends to commercial banks -- by 25 basis points. That cut was SARB’s first repo rate cut since Finance Minister Enoch Godongwana announced on 12th November last year that South Africa’s inflation midpoint target would be revised downwards to 3% from 4.5%.

In line with this historic shift in monetary policy, the country has also set a new inflation target range of 2% - 4%, moving away from the old target range of 3% - 6% that has been place for the past 25 years.

This means that the consumer price index (CIP), which measures household inflation, must at all times be within the target range of 2% - 4%, otherwise SARB will hike or cut interest rates if inflation threatens to breach either the upper or lower limits of the target range.

In December last year, the CPI was at 3.6% year-on-year, bang inside the 2% - 4% target range. SARB expects CPI to stay glued inside the target range over the next three years, even sliding down to hit the 3% target.

This projection leaves room for cuts down the line. Of late, South African consumers and businesses have become accustomed to interest rate cuts. SARB has cut interest rates five times since September 2024.

The cuts have lowered borrowing costs for households, particularly on mortgages, car loans, and personal loans while it emboldened a few businesses to borrow to finance their expansion.

The cuts left more money in the pockets and wallets of consumers, encouraging them to spend. This is reflected in household consumption, which was up more than 3% last year.

However, most businesses remained cautious about investing. Kganyago revealed that investment contracted in the first half of 2025, but recovered in the third quarter -- allowing the economy to achieve structurally higher growth.

South African consumers and businesses owe roughly R4.73 trillion. This credit was extended by commercial banks and non-deposit taking lenders through various loan types like business loans, mortgages, vehicle finance, personal loans, revolving credit (credit cards and overdrafts), and retail store credit.

Although inflation-targeting policies are primarily designed to contain inflation -- they are also capable of fending off deflation, which is also bad for the economy if left unchecked.

Deflation, whose symptoms present themselves as general decline in prices of goods and services, is an unwanted and unwelcome destroyer of economic wealth and jobs.

It poses an economic risk because it encourages consumers to hoard cash in a bid to delay spending to take advantage of falling prices.

When prices fall, they threaten profits. In response to this threat, businesses usually respond by downsizing production to reduce costs -- which in many instances means retrenching workers.

While businesses cut costs to respond to deflation, central banks cut interest rates to stimulate spending and prices to prevent an economic slump, or worse a prolonged recession.

In South Africa, the inflation target has been lowered to fight inflation, even though the same policy can technically be used to fight deflation.

However, South Africa has in the past faced another unwanted and unwelcomed economic problem known as stagflation -- a scary and dangerous concoction of rising inflation, low economic growth, and staggeringly high unemployment.

Stagflation comes from the marrying of two words – stagnation and inflation.

In the 1970s, Canadian-American economist Robert Mundell, figured it out that stagflation was caused by low aggregate supply as opposed to low aggregate demand.

He proposed that stagflation could be cured by cutting taxes instead of reducing interest rates to stimulate investment and production by businesses. Once taxes were slashed, Mundell believed that the availability of goods in the economy would automatically increase as businesses ramped up production.

But South Africa is facing its own fair share of supply-side constraints, which are caused by electricity and logistics infrastructure bottlenecks, shortage of critical skills, corruption, and restrictive and complex legislation.

These bottlenecks are investment killers that have conspired to stagnate the economy for the past 16 years. Over the next three years, the government plans to invest over R1 trillion to remove infrastructure constraints, which raise the cost of doing business and block investment.

While inflation and deflation are fought in South Africa through hiking or cutting interest rates, there is huge reservation about the effectiveness of inflation-targeting policy as a weapon to ward off inflation.

Critics of inflation targeting policy often refer to it as a “blunt instrument”. This is because of the kind of inflation that South Africa experiences is mostly cost-push, not demand-pull.

In other words, inflation in this country is not driven by excess demand caused by too much spending by consumers.

In South Africa, inflation is usually driven by high food prices caused by droughts or global commodity shocks; high fuel prices caused by rising crude oil prices and weak rand. Sometimes, it is driven by high electricity and administered prices caused by Eskom tariff hikes and increases in municipal rates.

In essence, South Africa’s inflation is fueled by supply-side shocks, which cannot be contained through hiking interest rates as interest rate hikes do not lower oil prices, fix load-shedding, or stop droughts.

So, when SARB raises the repo rate to hit the inflation target, it is merely acting on inflation stimulants it cannot control.

This is why the lowering of the inflation target did not go down well with South Africa’s labour unions. COSATU and SAFTU, both powerful labour union federations, condemned the decision to tighten the target by Godongwana, who is ironically a former trade unionist-turned politician.

The labour federations believe that the new target is restrictive. For many years, trade unions wanted inflation-targeting to be replaced with a more accommodative monetary policy that promotes and prioritises economic growth and employment creation.

The workers are essentially calling for SARB to adopt a looser monetary policy that keeps interest rates low instead of inflation targeting -- which punishes borrowers with high interest rates, even if consumers are responsible for fueling inflation due to excessive spending.

In the coming months, the criticism of inflation-targeting is likely to be muted, masked by the projected low inflation and interest rates cuts. But the minute SARB starts hiking interest rates aggressively, critics of inflation-targeting will emerge out of the woodwork to complain again.

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