6 December 2007
Introduction
The short-term inflation outlook has deteriorated since the previous meeting
of the Monetary Policy Committee (MPC). Food and energy prices have maintained
pressure on inflation and these pressures are expected to persist in the coming
months. At the same time, previous monetary policy actions are probably
beginning to have an impact on household consumption expenditure and this is
expected to help moderate inflation pressures over time. The MPC however has to
ensure that the short term impact of higher inflation does not allow inflation
expectations to become entrenched at higher levels.
Recent developments in inflation
CPIX inflation remained outside the target range for the seventh consecutive
month, reaching a 4-and-a-half-year high of 7,3 per cent in October 2007. Food
price inflation has continued to accelerate, measuring 12,4 per cent in
October. Most of the food categories in CPIX recorded double-digit rates of
increase, with the main contributions emanating from grain products, milk,
cheese and eggs, and vegetables. Meat price inflation, however, declined to 6,6
per cent. Petrol prices increased at a year-on-year rate of 12,0 per cent in
October following moderate increases in the previous three months. Administered
prices excluding petrol continued their upward trend and measured 8,5 per cent
in October.
There is however some evidence that upward pressure on other components of
inflation may be moderating. If food and petrol were excluded, CPIX inflation
would have measured 4,8 per cent in October, compared to 5,0 per cent in July
and August 2007. Low or negative rates of inflation are still being recorded in
the following categories: clothing and footwear, furniture, recreation and
communication.
Production price inflation in October 2007 remained high at 9,5 per cent,
which was marginally above that in the previous two months. Imported goods
inflation declined to 7,5 per cent while the prices of domestically produced
goods increased by 10,2 per cent. Prices of agricultural and manufactured foods
increased by 26,1 per cent and 17,5 per cent respectively which suggests that
further pressures on retail food prices can be expected in the coming
months.
The outlook for inflation
The most recent central forecast of the Bank indicates a further
deterioration in the inflation outlook, particularly in the short term, when
compared to the previous forecast. CPIX inflation is now expected to peak at
around 7,8 per cent in the first quarter of next year. Thereafter CPIX
inflation is expected to decline to below the upper end of the target range by
the final quarter of 2008. A gradual downward trend is expected to persist and
to measure 5,2 per cent in the final quarter of 2009. The higher trend is a
result of higher administered price assumptions, particularly for petrol and
electricity over the forecast period.
Despite the higher short-term trend in inflation, expectations remain
contained within the inflation target range. According to the inflation
expectations survey that is conducted on behalf of the Bank by the Bureau for
Economic Research (BER) at the University of Stellenbosch, there was only a
slight deterioration in expectations in the fourth quarter compared to those in
the third quarter when a significant increase in expectations was recorded.
CPIX inflation in 2008 is now expected to average 5,9 per cent, compared to the
5,8 per cent expected in the previous survey. Significantly, CPIX inflation
expectations for 2009 remained unchanged at 5,6 per cent.
Expectations as reflected in the break-even inflation rates, which is the
yield differential between conventional and inflation-linked bonds, reflect
some deterioration. Break-even inflation rates over different maturities
decreased between the August and October meetings of the MPC. Since the October
meeting, break-even inflation has increased somewhat over all maturities, but
still remains below the six (6) per cent level.
The main risks to the inflation outlook emanate from food, petrol and
electricity price prospects. International oil prices have continued to remain
an upside risk factor. At the time of the October meeting of the MPC, North Sea
Brent crude oil prices were trading at around US$78 per barrel. Since then
prices increased to peak at almost US$100 per barrel, although in recent days
prices have fallen declined to around US$90 per barrel. Domestic petrol prices
have been adversely affected by these international trends, and the local price
of 93 octane petrol increased by three (3) cents per litre in November and by
43 cents per litre in December.
The degree of upside risk from food price increases may have subsided over
time, but food prices nevertheless remain the main contributors to inflation.
As noted, production prices indicate that further pressures can be expected on
CPIX in the short term. However there are expectations of some moderation
during the course of next year as a result of base effects and more favourable
weather conditions and higher crop estimates. Futures prices generally reflect
an expectation of lower prices, particularly for maize, during 2008. Global
food price pressures are nevertheless expected to persist for some time.
Electricity prices in particular pose a significant risk to the inflation
outlook. The National Electricity Regulator is due to make a decision on the
application by Eskom to raise electricity tariffs by 18 per cent in 2008 and 17
per cent in 2009 in order to help finance its capital expenditure
programme.
Despite these risks and pressures, not all of the recent developments have
been negative from an inflation perspective. In particular, there is evidence
of a lagged response by the economy to the previous monetary policy tightening.
Household consumption expenditure continues to show some signs of moderation in
response to the changed monetary policy stance and lower household disposable
income growth. Final consumption expenditure by households grew by 4,5 per cent
in the third quarter of 2007, compared to a revised 4,9 per cent growth in the
second quarter. This third quarter moderation was a result of a marked
deceleration in real expenditure on semi-durable goods in particular. The real
value of retail sales remained broadly unchanged from the second quarter to the
third quarter. Sales of new vehicles also remained subdued. Despite these
developments, the FNB/BER Consumer Confidence Index reflected an increase in
consumer confidence during the fourth quarter.
Reflecting the slowdown in household consumption expenditure, credit
extension to the private sector has shown some signs of moderation, but
nevertheless remains at high levels. Twelve-month growth in total loans and
advances had declined gradually over the past few months. Growth over twelve
months in loans and advances extended to the household sector declined to 20,1
per cent in October 2007, having peaked at 28,2 per cent in February 2006. The
growth rate of loans and advances to the corporate sector declined to 29,7 per
cent in October. Household debt as a percentage of household disposable income
increased to 77,4 per cent in the third quarter.
Asset price growth, which in the past has helped to underpin domestic
demand, appears to be somewhat restrained. Having recovered from the initial
impact of the sub-prime developments in the United States (US) and euro area,
the JSE limited has been fairly volatile, in line with the uncertainties that
prevailed in the global equity markets. In addition, according to Absa Bank,
the year-on-year rate of increase in house prices in the middle segment has
declined further to 13,6 per cent in October.
Fiscal policy continues to be supportive of monetary policy. In the October
Medium Term Budget Policy Statement, the commitment to fiscal prudence was
confirmed with the projection of fiscal surpluses for the coming three
years.
Output growth remained strong, with Gross Domestic Product (GDP) growth
measuring 4,7 per cent in the third quarter of 2007 compared to a revised 4,4
per cent in the second quarter. Economic growth therefore continues to be
around rates consistent with the potential growth rate of the economy. Growth
in gross fixed capital formation remained strong in the third quarter, and this
is expected to underpin growth going forward.
The exchange rate of the rand has displayed a higher degree of volatility in
recent weeks, but nevertheless has remained relatively unchanged since the
previous meeting of the MPC. The relative strength of the rand has been
underpinned by sustained capital inflows which financed an expanding current
account deficit in the third quarter of 2007. The deficit, which measured
approximately 8,1 per cent of GDP, was driven mainly by increased imports of
manufactured goods, as well as by a marked acceleration in service payments to
non-residents. Despite this, capital inflows were sufficient to allow for a
further accumulation of foreign exchange reserves by the Bank. At the end of
November, the official gross gold and other foreign exchange reserves had
increased to US$32,3 billion, and the international liquidity position to
US$30,7 billion.
The outlook for the international economy remains uncertain, with continued
turbulence in international financial markets. The reported losses of
institutions with exposure to the US sub-prime mortgage market have exceeded
expectations, and there are concerns that the downturn in some of the advanced
economies may be more severe than originally anticipated. Global inflation
appears to be contained although oil and food prices continue to pose a risk to
the outlook.
Monetary policy stance
The assessment of the MPC is that the balance of risks to the inflation
outlook continues to be on the upside. Therefore the MPC has decided to adjust
the repurchase rate by 50 basis points to 11,0 per cent per annum with effect
from Friday, 7 December 2007. The MPC will continue to monitor relevant
developments and take the necessary steps to ensure that inflation returns to
within the target range.
Contact person:
Samantha Henkeman
Tel: 012 313 4669
E-mail: Sam.Henkeman@resbank.co.za
Addendum to the Monetary Policy Committee statement of 7 December 2006
Monetary Policy Committee Meeting dates for 2008:
30 and 31 January 2008
9 and 10 April 2008
11 and 12 June 2008
13 and 14 August 2008
8 and 9 October 2008
10 and 11 December 2008
Issued by: South African Reserve Bank
6 December 2007
Source: South African Reserve Bank (http://www.reservebank.co.za)
