Reserve Bank Governor, Mr TT Mboweni
16 August 2007
The Monetary Policy Committee (MPC) met and evaluated domestic and
international economic developments as well as the prospects for inflation
going forward. In this context the MPC noted that recent financial market
developments in some of the developed economies have had spill over effects on
emerging markets including South Africa.
A number of central banks have responded by injecting significant amounts of
liquidity into their banking systems in order to ensure an orderly adjustment
to the liquidity squeeze that was being experienced. The focus of the South
African Reserve Bank remains to ensure a return of the inflation rate to within
the target range.
Recent developments in inflation
Year-on-year inflation as measured by the consumer price index for
metropolitan and other urban areas excluding the interest cost on mortgage
bonds (CPIX) increased at a year-on-year rate of 6,4 percent in both May and
June 2007, following an increase of 6,3 percent in April. CPIX inflation has
exceeded the upper end of the inflation target range of six percent for the
past three months. The main causes of the upward trend in inflation remain food
and energy, but broader underlying pressures are also evident. If food and
energy prices were excluded, CPIX inflation would have measured 4,6 percent in
May and 4,7 percent in June, compared to 3,8 percent in December 2006. This
indicator has been rising consistently since the middle of 2006 when it
measured 2,5 percent.
Food prices increased at year-on-year rates of 9,0 percent and 9,4 percent
in May and June 2007 respectively, with grain product prices increasing by 13,4
percent in June. Meat price inflation has been declining steadily since it
peaked late last year, but nevertheless recorded an increase of 9,9 percent in
June. Petrol prices increased at year-on-year rates of 13,7 percent in May and
11,1 percent in June as a result of a cumulative increase of R0,57 per litre in
these two months.
Prices of services, which tend to adjust more slowly than those of goods,
have also been displaying an upward trend, having increased at a year-on-year
rate of 5,7 percent in June, compared to 4,6 percent in January 2007. The
higher inflation trend is also observed in administered prices excluding
petrol, which have increased at rates of around 5,5 percent since October 2006.
Price declines in clothing, footwear and furniture continue to moderate
pressures on inflation.
Production price inflation remains high, but declined to a year-on-year rate
of 10,4 percent in June, following rates in excess of 11 percent in the
previous two months. The prices of agricultural goods have been increasing at
year-on-year rates of almost 20 percent since March 2007, whereas manufactured
goods prices increases moderated to 6,4 percent in May and June. Imported goods
inflation declined from 11,7 percent in May 2007 to 9,4 percent in June.
The outlook for inflation
The most recent central forecast of the Bank indicates a slight
deterioration in the inflation outlook, particularly in the short term, when
compared to the previous forecast. CPIX inflation is now expected to remain
above the upper level of the inflation target range at an average of around 6,3
percent before declining to within the inflation target range in the second
quarter of 2008. Thereafter it is expected to follow a downward path, to reach
around 5,1 percent by the end of 2009. The higher trend results from a
higher-than-expected second quarter outcome which raised the starting point of
the forecast, and a revised assumption for international oil prices.
The MPC identified a number of upside risks to the inflation outlook. These
include oil and food prices, and high rates of household consumption
expenditure. The assessment of most of the other variables was relatively
unchanged, although there is some uncertainty about the potential impact of
international financial market developments.
Food prices remain a threat to the inflation outlook despite the declining
trend in meat price increases. High rates of increase in the spot prices of
maize and wheat during the first half of this year are expected to sustain the
higher food inflation. Of further concern are the year-on-year increases in
June in the prices of agricultural products and manufactured food at the
producer price level measuring 18,7 percent and 15,0 percent respectively.
These indicate possible further pressures on food prices at the retail level in
coming months.
North Sea Brent crude oil is currently trading at around US$72 per barrel,
which is similar to prices prevailing at the time of the previous MPC meeting.
During July however, the price rose to levels slightly below US$80 per barrel.
More recently, prices have moderated partly as a result of concerns about the
growth outlook in the United States and the sell-off in financial markets. The
domestic petrol price declined in July and August by a total of R0,23,
reflecting exchange rate and product price movements. Despite this recent
respite, risks to inflation emanating from this source are still considered to
be on the upside.
There is little evidence of a sustained slowdown in household consumption
expenditure growth. The FNB/BER Consumer Confidence Index still remains near
record levels despite a moderate decline in the second quarter of 2007. Retail
sales growth remains robust, although the most recent data shows that the
year-on-year increase in June declined to 6,4 percent compared to rates of
growth of 5,9 percent and 9,2 percent in April and May respectively. Retail
sales of household furniture, appliances and equipment declined by 13,5 percent
in June compared to a year ago. Sales of private motor vehicles have also
continued to decline. The seasonally adjusted number of new passenger vehicles
sold in the three months to July 2007 reflected a decrease of 5,4 percent
compared to the previous three months.
Growth in credit extension to the private sector remains high, and it is
premature to assess the impact on credit extension of the introduction of the
National Credit Act in June. Twelve-month growth in banks' loans and advances
extended to the private sector increased at a rate of 27,9 percent in June.
Adjusted for securitisation transactions, the increase would have been 30,3
percent. Growth in loans and advances to the corporate sector measured 36,2
percent in June, compared to 33,3 percent in May, while growth in credit
extended to the household sector moderated from 22,8 percent in May to 21,5
percent in June. Year-on-year growth of asset-backed credit has been declining
steadily over the past few months, recording a growth rate of 23,6 percent in
June.
Wage settlements have been trending upwards. According to Andrew Levy
Employment Publications, the average level of wage settlements measured 6,5
percent in 2006. In the first half of 2007, wage settlement rates have averaged
6,8 percent, but a growing number of recent settlements have been closer to 8
percent. This may still be consistent with the inflation target if labour
productivity growth is accounted for. Nevertheless the upward trend is of some
concern given the importance of wage developments in the price formation
process.
As a result of the uncertainties in the international financial markets and
the strengthening of the US dollar, the rand exchange rate has depreciated
somewhat, particularly over the past few days. Before the onset of the current
round of global financial market volatility, the rand had appreciated due to
amongst others the weakness in the US dollar against other currencies, and
anticipated capital inflows related to possible merger and acquisition
activity. At one stage the rand had reached levels slightly below R6,80 at a
time when the US dollar had reached an historic low against the euro. However
the increased global risk aversion and a recovery in the US dollar reversed
this trend and the rand is currently trading at a level of around R7,45
compared to R7,22 at the time of the previous meeting. Since the beginning of
the year, the nominal effective exchange rate of the rand has declined by 6,2
percent.
Despite the global financial market developments noted above, non-resident
interest in South African assets, in particular equities, has remained
positive. Since 20 July, when emerging market spreads started to widen,
non-residents have been net purchasers of equities totalling in excess of R11
billion, although in the past few days they have been moderate net sellers to
the value of around R150 million. The sustainability of these inflows will
depend in part on global liquidity conditions as well as domestic growth
prospects.
Conditions in the local foreign exchange market during July allowed for
further accumulation of foreign exchange reserves. At the end of July gross
gold and foreign exchange reserves had increased by US$1,06 billion to US$29,33
billion, while the international liquidity position had increased to US$26,97
billion.
The domestic economy continues to grow at a brisk pace but there are some
signs of moderation. GDP grew at an annualised rate of 4,7 percent in the first
quarter of 2007, down from 5,6 percent in the final quarter of 2006. Mining
production has continued to disappoint despite favourable commodity prices. In
the second quarter of 2007, the physical volume of mining production remained
under pressure, declining by 1,4 percent compared to the previous quarter. The
physical volume of manufacturing production also came under pressure in the
second quarter when it grew by only 0,1 percent. Nevertheless the index of
utilisation of productive capacity in the manufacturing sector increased to
86,8 percent in the second quarter. The RMB/BER Business Confidence Index
declined marginally in the second quarter of 2007. A more positive outlook is
provided by the Investec/BER Purchasing Managers Index which increased in July
2007 following three consecutive monthly declines. Despite some negative
indications, growth is expected to be underpinned in the coming months by the
continued acceleration in the growth of real gross fixed capital formation
which increased at a year-on-year rate of almost 22 percent in the first
quarter of 2007 and brought the ratio of fixed capital formation to GDP to over
20 percent.
At this stage there is no evidence that the recent turbulence in the
international financial markets will have marked effects on the domestic growth
outlook, although this will depend to some extent on the impact of these
developments on the United States growth performance. To date the impact has
been felt in the exchange rate, and to a greater extent on the capital market.
Although the prices of equities on the Johannesburg Stork Exchange (JSE)
Limited declined from their recent elevated levels, at the end of trade on 15
August, the All-share Index was still over eight percent higher than that
prevailing at the beginning of the year. This suggests that the possible
impacts on consumption via the wealth effect and on investment are likely to be
limited.
The international environment has become increasingly volatile and
uncertain. The updated International Monetary Fund (IMF) World Economic Outlook
forecasts published in July this year show a 0,3 percent increase in expected
world GDP growth for both 2007 and 2008. World inflation is expected to remain
more or less unchanged and average 3,5 percent for 2007 and 2008. This forecast
was made before the recent turmoil on the international financial markets and
it is too early assess the risks that these developments may pose to the global
growth and inflation outlook.
Monetary policy stance
Having considered recent developments, the MPC has decided that a further
adjustment in the monetary policy stance is required in order to ensure that
CPIX inflation returns to within the target range. Accordingly, the repo rate
is adjusted by 50 basis points to 10,0 percent per annum with effect from 17
August 2007. The MPC will continue to monitor the relevant economic and
financial developments in order to ensure that its mandate is fulfilled.
Contact person:
Brian Hoga
Cell: 012 313 4448
E-mail: Brian.Hoga@resbank.co.za
Issued by: South African Reserve Bank
16 August 2007
Source: South African Reserve Bank (http://www.resbank.co.za)
