2 February 2006
Introduction
The inflation outlook remains promising despite the risks posed by an
uncertain global environment. World growth is expected to remain buoyant in
most regions, although international oil price developments continue to weigh
on global growth and inflation prospects. At the same time, world growth has
underpinned international commodity prices which, along with positive
non-resident investor sentiment, have contributed to the recent strength in the
rand. This has been despite monetary policy tightening in a number of
countries, in particular the United States of America and the euro area.
Domestically, there are few signs of a slowdown in domestic demand. Output
growth in the manufacturing and mining sectors have shown some signs of
moderation in the final quarter of 2005, although overall growth is expected to
remain relatively strong. Domestic demand conditions and oil price
uncertainties pose the biggest risk to the inflation outlook.
Recent inflation developments
Inflation as measured by the consumer price index for metropolitan and other
urban areas excluding the interest cost on mortgage bonds (CPIX) declined to
3,7 per cent in November, but increased to 4,0 per cent in December. Although
domestic petrol prices were decreased by a total of R0,61 in these two months,
these prices nevertheless increased on a year-on-year basis by 17,7 per cent
and 16,0 per cent respectively. If petrol prices were excluded from this index,
CPIX inflation would have measured 3,0 per cent and 3,4 per cent in November
and December respectively. For the year as a whole, CPIX inflation averaged 3,9
per cent in 2005 compared to 4,3 per cent in 2004.
Services price inflation has declined consistently since June 2005, and
measured 5,0 per cent and 4,7 per cent in November and December respectively,
compared to 5,2 per cent in October. Administered price inflation has also
continued to decline, falling to 7,5 per cent and 7,0 per cent in November and
December respectively. If petrol prices were excluded, administered prices
would have increased at a year-on-year rate of 4,3 per cent in each of the
three months to December 2005, more or less in line with overall CPIX
inflation.
Clothing and footwear continue to put downward pressure on inflation, and
prices in these two categories declined at year-on-year rates of around 4 per
cent in the last 4 months of 2005. By contrast, food prices rose at an annual
rate of 4,0 per cent in December, compared to the average for the year of 2,1
per cent. The December increase in food prices was mainly attributable to meat
prices which rose at a year-on-year rate of 6,9 per cent, compared to 1,1 per
cent the previous month.
Production price inflation has exhibited a more discernible rising trend,
with year-on-year producer price inflation measuring 4,5 per cent and 5,1 per
cent in November and December respectively. Imported goods inflation measured
5,7 per cent and 6,5 per cent in these two months while domestically produced
goods increased by 4,0 per cent and 4,6 per cent respectively. Producer price
inflation for 2005 as a whole averaged 3,1 per cent compared to 0,6 per cent
the previous year.
The outlook for inflation
Since the last MPC meeting, the inflation forecast of the South African
Reserve Bank has changed somewhat, with the inflation trajectory now expected
to follow a more moderately rising trend compared to that discussed at the
previous meeting. According to the central forecast, CPIX inflation is expected
to peak at around 4,9 per cent in the first quarter of 2007 where after it is
expected to decline slowly to reach around 4,7 per cent at the end of the
forecast period.
As usual the MPC considered the factors that brought about this outlook as
well as the related risks. The robust domestic demand is an important factor
which could negatively affect the inflation outcome. To date, however, there
have not been any significant inflationary consequences, although this could
change if demand growth were to accelerate unchecked.
Indications are that household consumption expenditure growth has remained
strong. According to the latest FNB/BER survey, consumer confidence reached a
record high in the fourth quarter of 2005. New vehicle sales reached an
all-time high in December, and increased by 25,7 per cent over the year as a
whole. Retail sales have also continued to grow robustly, and recent trading
and earnings updates from retailers, as well as credit extension data, suggest
that sales growth in November and December of 2005 probably matched or exceeded
the 7,7 per cent year-on-year growth recorded in October.
The strong domestic demand has been underpinned by the growth in credit
extension. Total loans and advances to the private sector grew at year-on-year
rates of around 20 per cent during October and November 2005, and rose to 21,4
per cent in December. This growth in total loans and advances has been driven
mainly by an increase in asset-backed credit. Mortgage advances extended to the
household sector remain particularly strong.
Asset price developments and their related wealth effects have probably also
contributed to the consumption boom. The housing market remains buoyant,
although the rate of increase in house prices has moderated somewhat. In
December 2005, the ABSA house price index increased on a month-on-month basis
by 0,7 per cent. Moreover the recent stellar performance of the JSE Securities
Exchange could also impact on consumer demand. During the past few months,
share prices have continued to reach new highs. Since reaching a low point for
2005 in April, the all-share index has increased by approximately 60 per
cent.
The brisk domestic demand has had an impact on the current account deficit
which increased to 4,7 per cent of GDP in the third quarter of 2005.
A sizeable trade surplus was recorded in December following a sharp decline
in imports. This has contributed to a significant narrowing of the trade
deficit from R19,6 billion in the third quarter to R1,4 billion in the fourth
quarter of 2005. This is likely to result in a narrowing of the current account
deficit in that quarter.
Continued strong domestic demand is expected to maintain pressure on the
current account. However the current account deficit continues to be more than
adequately financed by capital inflows which in turn are being attracted by
improved economic growth prospects in South Africa. The overall balance of
payments has remained in surplus, and the level of official gross gold and
foreign exchange reserves increased to US$22,2 billion at the end of January
2006.
The coincident business cycle indicator declined slightly in October 2005,
although indications are that the economy is still growing at a healthy but
perhaps more moderate pace. The physical volume of mining production declined
in October and November, while manufacturing output declined in October, mainly
as a result of supply issues in the petroleum industry related to the change to
lead-free fuel. Although refinery shut-downs continued into November,
manufacturing output recovered somewhat in that month, recording a year-on-year
growth of 2,1 per cent. The latest Investec Purchasing Managers Index (PMI)
also indicates that there might be a general slackening in manufacturing sector
growth. The various business confidence indices indicate that confidence
generally remains at high levels.
Two exogenous factors, namely oil and food price developments, are potential
risks to the inflation outlook. At the time of the last MPC meeting the price
of Brent crude oil was around US$55 per barrel, but since the beginning of 2006
international oil prices have risen again to levels of around US$65 per barrel.
Apart from continued strong demand for oil, upward pressure on prices has
emanated from supply threats related to geo-political concerns. The higher
prices have already resulted in a domestic petrol price increase of R0,14 per
litre in February, which more than offset the R0,06 per litre decrease in
January.
Developments in food price inflation are also a potential concern. As noted
earlier, food price inflation has accelerated but is still relatively low. Food
price inflation is expected to be higher in 2006 partly as a result of the low
base in 2005. Furthermore, the higher food price inflation evident in
production prices, along with higher maize prices also point to a possible
acceleration in retail food price inflation going forward.
There are a number of factors which have contributed to the positive
inflation outlook. These include continued fiscal discipline, low world
inflation and well-anchored inflation expectations. Inflation expectations as
indicated in the long-term break-even inflation rates, measured as the yield
differential between conventional bonds and inflation-linked bonds, point to
some improvement in inflation expectations since the last meeting.
Nominal wage growth recorded a year-on-year increase of 7,9 per cent in the
third quarter of 2005. However positive productivity growth ensured that unit
labour cost increases have remained consistent with the inflation target. Unit
labour cost in the formal non-agricultural sectors recorded annual increases of
3,5 per cent and 4,2 per cent in the second and third quarters of 2005
respectively. Unit labour cost in manufacturing grew at an annual rate of 0,2
per cent in the third quarter. These moderate trends in wage increases are
consistent with the latest Andrew Levy Employment Publications report which
shows that average wage settlements declined from 6,9 per cent in 2004 to 6,3
per cent in 2005.
Since the last meeting of the MPC, the nominal effective exchange rate of
the rand has appreciated by approximately 1,7 per cent. During this period, the
rand has fluctuated between R6,75 to the US dollar in November 2005 and R5,95
in January, and is currently trading at levels around R6,10. The strengthening
of the rand was in part a reflection of US dollar depreciation. In addition,
the rand was supported by high commodity prices, expectations of further
foreign direct investment inflows, positive South African economic data as well
as strong demand from non-residents for South African equities.
Monetary Policy Stance
There are significant risk factors to the inflation outlook that the
Monetary Policy Committee is mindful of. Nevertheless, the Monetary Policy
Committee has decided for now to leave the repo rate unchanged at 7 per cent
per annum. The MPC will continue to exercise vigilance in order to ensure that
CPIX inflation stays within the inflation target range.
Contact person:
Cathy Powers
Tel: (012) 313 4420
E-mail: Cathy.Powers@resbank.co.za
Issued: South African Reserve Bank
2 February 2006
Source: South African Reserve Bank (http://www.reservebank.co.za)
Kate
