National Treasury’s 2025 Medium Term Budget Policy Statement (MTBPS) formalises a point target for inflation of 3.0%, with a tolerance band of one percentage point, and sets out a clear, time-bounded path to re-anchor expectations to that level through close fiscal-monetary co-ordination. This is not a cosmetic refinement but a regime clarification that shifts South Africa from an implicit midpoint to an explicit anchor. It reflects the public-interest conclusion that the aggregate welfare gains from a lower and narrower target exceed the transitional frictions. The MTBPS is explicit that this policy can be executed without compromising fiscal objectives, given existing consolidation and institutional alignment.
Pictured: Reza Ismail, Head of Bonds at Prescient Investment Management
The intellectual foundations for this move have been laid by the Reserve Bank’s recent research, which argues - on both empirical and model-based grounds - that a lower inflation target reduces the priced average expected inflation compensation priced into bond yields, as well as the variance around this quantity (the so-called “inflation risk premium”). Recent examination of a decomposition of South African bond yields (via econometric routines) reveals that exactly this moderation in the components of bond yields relating to inflation compensation has indeed taken place. In addition, a lower target, improves policy transmission, and supports aggregate demand.
South Africa’s previous target architecture, wide and relatively elevated by peer standards, sustained a larger inflation component in long bond yields and a higher uncertainty surcharge than was strictly necessary. A tighter anchor addresses both dimensions: level and variance. In that precise sense, the MTBPS converts a research-backed proposition into binding policy.
The implementation architecture is institutionally robust. The Minister of Finance and the Reserve Bank Governor will co-ordinate policy settings to ensure that the path of actual inflation and the distribution of expectations converge to the new anchor in an orderly fashion over the next two years. The MTBPS situates this within a multi-year review, external benchmarking, and explicit inter-institutional governance - features that enhance credibility and, by extension, lower macro-financial volatility. Process credibility is not incidental: it is a transmission channel in its own right, reflected in narrower confidence bands around forward-looking prices.
A gradualist strategy is deliberately chosen to maximise durability. External scenario work undertaken by the SARB underscores that re-anchoring can be accomplished with modest output costs when actual inflation is already near the new target and when policy communication is consistent. The previous step-down in the effective target midpoint was absorbed in roughly three years; the present configuration suggests a shorter horizon, precisely because initial conditions are more favourable. The operative principle is to privilege credibility and minimise output volatility rather than to chase headline speed.
For market structure, the mechanism is straightforward. A credible lower anchor reduces the average expected inflation component embedded in nominal yields and trims compensation for inflation uncertainty (the inflation risk premium); together these effects reduce the economy-wide cost of capital. This is the key repricing channel that operates across the sovereign curve and into bank and corporate funding costs. It is cumulative rather than episodic: as expectations harden, the curve embeds a smaller inflation-risk surcharge.
A second channel is equally material: term-premium compression via lower macro-volatility and diminished policy uncertainty. When investors assign lower probabilities to adverse inflation surprises and disruptive policy adjustments, the required compensation for bearing duration falls. The consequence is tighter sovereign spreads and, via the benchmark role of the sovereign curve, a systematic easing in private credit pricing. The investment calculus shifts as hurdle rates decline in level and dispersion.
External balance considerations reinforce the domestic repricing. A lower inflation anchor narrows differentials vis-à-vis trading partners, supports a more stable and competitive real exchange rate, and improves the pricing of currency hedges. These changes lower imported cost pressures and stabilise financial conditions, complementing the internal disinflation strategy. In sum, the new target functions as a competitiveness instrument as much as a nominal anchor.
Treasury is unambiguous about near-term arithmetic. Disinflation slows nominal GDP growth, and because tax bases are predominantly nominal, revenue growth is initially softer while several expenditures remain sticky in nominal terms. The effect is a temporary tightening of fiscal space even as the policy change itself is designed to reduce funding costs over time. These transitional optics are operational in nature; they do not negate the medium-term efficiency gains.
Over the medium horizon, the policy mix is net-positive for fiscal sustainability. Narrower inflation and uncertainty premia reduce debt-service costs and, conditional on expenditure control, improve the primary balance, supporting debt stabilisation in the outer years. The MTBPS locates this strategy in a coherent macro-institutional frame, explicitly linking the inflation anchor to the fiscal framework. The credibility dividend is the mechanism through which the fiscal accounts benefit.
Real-economy transmission operates through the level and stability of interest rates. A lower and credible target allows the policy rate to average lower across the cycle without jeopardising price stability, supporting household consumption, private fixed investment, and employment. The relevant gain is not the next policy move but the steadier and lower mean around which short-term rates oscillate. That is how trend growth is lifted without courting overheating.
Microeconomic frictions also diminish. Lower forward-looking inflation enters wage bargaining and firms’ price-setting, stabilising unit labour costs and reducing the need for precautionary liquidity buffers. Planning horizons lengthen and pricing bands narrow, lowering the internal cost of capital and improving the viability of longer-duration projects. These compounding effects favour capital deepening and productivity growth.
Peer benchmarking and reputational dynamics matter for spreads and tenors. Moving to a point target of 3.0% places South Africa within the mainstream of better-performing emerging market inflation targeters and communicates a durable preference for low and stable inflation. Investors reward such alignment with tighter spreads and more patient capital. Reputational capital, in this domain, is convertible into financial capital.
Adjustment costs should be kept in proportion. With actual inflation already near the new objective, and with institutional alignment in place, the output cost of re-anchoring is likely to be modest by historical standards. Evidence on expectations formation suggests that forward measures are strongly anchored by the stated target, especially at the one-year-forward horizon, implying less aggressive real-rate adjustments are required. That, in turn, shortens the transition and lowers the sacrifice ratio.
It is worth stating plainly, in view of our prior analysis. The argument advanced earlier in our Prescient paper titled “Three Cheers for Three Percent” - namely that a credible 3.0% anchor would compress the expected inflation path, lower the inflation-risk premium, and discipline the term premium, thereby reducing the sovereign cost of capital - has now been adopted as policy and is visible in the official macro-fiscal narrative.
The policy now matches the analysis, and the yield curve will do the rest as credibility accumulates. This is the textbook sequence: anchor, compress, invest.
Finally, why does a lower cost of capital act as a springboard for real growth? Because investment appraisal is governed by discount rates and risk spreads: when sovereign and bank curves shift down and stabilise, more projects clear internal hurdles, cash-flow breakevens improve, and firms pivot from defensive replacement to capacity-expanding, productivity-enhancing outlays. Over time, the economy’s capital stock rises, the composition of growth tilts toward tradables and infrastructure, and potential output increases. That is the growth dividend of credible disinflation.
The finance-to-growth pipeline also depends on market depth and tenor. Credible disinflation compresses sovereign spreads and lengthens maturities, which transmits into corporate bond pricing, term lending, and public–private partnership finance while reducing rollover risk. This lowers the volatility tax on investment and makes long-duration projects - energy, logistics, water and digital infrastructure - more attractive and credible. The MTBPS’s anchor is therefore not merely a monetary-policy refinement; it is a growth strategy executed through the price of capital.
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