What will the South African Reserve Bank’s monetary policy committee (MPC) decide about interest rates on May 28? When economies are hit by a large supply shock, such as the current global energy crisis, central banks face the dilemma of either temporarily overlooking it or immediately responding to it to ensure that inflationary expectations remain anchored.
A recent topical IMF research paper, “The Central Bank‘s Dilemma: Look Through Supply Shocks or Control Inflation Expectations?”, conceptualises the key challenges that the MPC is now also confronting.
As a net oil importer with structural growth constraints, South Africa is especially exposed to sustained energy price shocks. Higher oil prices historically act as a constraint on global and many national economies’ growth, while simultaneously heightening inflation. This dual impact complicates macroeconomic management. It also disproportionately affects emerging markets. The IMF study concludes that “it is optimal for a central bank to initially look through supply shocks until a threshold is reached, then pivot to a more hawkish anti-inflation stance”.
The MPC therefore does not need to choose between credibility and caution. It can preserve its anti-inflation credentials through a firm statement on risks while still pausing rates until there is clearer evidence that the oil shock is feeding into wages. prices and expectations.
A widespread view is that a 25bps increase may be possible. but even a small rise could have a negative “megaphone” impact on business and consumer confidence. So what is the latest data conveying to the MPC? Will a large global supply-side shock perhaps become a domestic demand-side one? For central banks, the major concern is not the rising headline inflation but rather whether there is any evidence of second-round effects emerging in the economy. In short, whether there are definite signs that a wage–price spiral may be developing.
The Bank must remain committed to its new 3% inflation target while recognising that the transition must be carefully managed in a weak-growth environment. Faced with elevated economic uncertainty, the challenge to the MPC is to craft its message around its anti-inflation narrative while remaining open to the possibility that alternative narratives may be valid. The Bank has also hinted that an interest rate hike now may be preventative.
A pre-emptive interest rate rise may be tempting if the MPC wants to reinforce its anti-inflation credibility before second-round effects become apparent. But this would be premature now, in the absence of convincing evidence. The right decision must be a broad judgement call, ultimately based on an assessment of the overall balance of risks. South Africa does have economic buffers and some policy space to decide the threshold for higher rates.
Earlier this year, headline inflation was down to 3%, and inflationary expectations were at their lowest in several years. The MPC previously believed that, in a “worst-case” oil price scenario, headline inflation would rise to an average of about 4%. Monetary policy is. In any event, still in restrictive territory. In addition, GDP growth forecasts for 2026 have been generally cut, so demand inflation is not a threat. The 2026 budget also provided a degree of fiscal credibility, and the flexible exchange rate is a partial shock absorber.
A convergence of weak growth and higher inflation does raise the possibility of a stagflationary environment emerging. But while the risk may exist, it remains an outlier prospect for now. Indeed, accelerating the pace of growth-friendly reforms to which both the public and private sectors are already committed would help lower the risk of stagnation in South Africa.
The MPC’s decision on rates will therefore test whether it has got the timing right. The recent global reaction from most central banks is that they can afford to wait and see. There remains a persuasive case for an MPC statement on May 28 that conveys a hawkish message to business and consumers about a potential shift toward a higher-for-longer interest rate outlook but is combined with another pause in rates for now.