African Reserve Bank Governor, Mr TT Mboweni
7 December 2006
Introduction
Inflation has continued its upward trend but is still within the inflation
target range. Credit extension and domestic demand remain strong and there are
only tentative signs that household consumer demand may be responding to the
tighter monetary policy stance. The recent revisions of the gross domestic
product (GDP) data show that the economy has been growing at a faster rate than
previously estimated. Reflecting the strong economy, the equity market has
reached new highs.
The outlook for the international economy remains somewhat mixed with good
growth performances in Europe and Asia and some weakness in the United States
(US) economy. The resulting weakening of the US dollar against some of the
major currencies and the rebounding of investor confidence in emerging markets
has influenced the rand and other currencies.
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) declined to 5,0 percent in October 2006 from 5,1 percent in
September. The outcome, however, was higher than expected following the 50
cents per litre reduction in the petrol price in October. Petrol and diesel
prices increased at a year-on-year rate of 0,2 percent in October compared to
22,1 percent in August. The lower petrol price inflation combined with
continued sizeable declines in the prices of clothing and footwear contributed
to the moderation in goods price inflation from 6,0 percent in August to 5,1
percent in October. However, this favourable development was offset by the
increase in services inflation from 3,5 percent in August to 4,6 percent in
October.
The food category remained the main inflation driver. Food price inflation
increased from a year-on-year rate of 7,2 percent in August 2006 to 7,9 percent
and 9,4 percent in September and October respectively. Meat prices increased at
a year-on-year rate of almost 20 percent in October whilst the prices of fish
and other seafood increased by 11,0 percent. The significance of the meat price
developments is illustrated by the fact that if this sub category were
excluded, CPIX inflation would have measured approximately 3,8 percent in
October. Housing services were primarily responsible for the increase in
services inflation in September and October. Administered prices excluding
energy increased at a year-on-year rate of 5,5 percent in October up from 4,2
percent in August.
Production price inflation continued to increase markedly and across a broad
spectrum of categories. Measured year-on-year, production price inflation had
declined to 9,0 percent in September 2006 from 9,2 percent the previous month.
However, in October the year-on-year increase was 10,0 percent. Imported goods
inflation measured 10,4 percent in October compared to 8,2 percent in
September. Domestically produced goods inflation increased to 9,9 percent
compared to 9,2 percent in the previous month. The categories displaying the
highest year-on-year increases included agricultural products, manufactured
food and electricity, gas and water.
The outlook for inflation
The most recent central forecast of the South African Reserve Bank (the
Bank) forecasting model indicates a moderate improvement in the inflation
outlook compared to the forecast considered at the October meeting of the MPC.
CPIX inflation is expected to breach the upper level of the inflation target
range in the second quarter of 2007. Thereafter, CPIX inflation is expected to
follow a downward path to just above five percent at the end of the forecast
period in 2008. The more favourable outlook is a result of the previous
monetary adjustments and a consolidation of oil prices at around US$60 per
barrel.
Inflation expectations have shown a slight deterioration in the fourth
quarter of 2006. According to the latest survey conducted on behalf of the Bank
by the University of Stellenbosch based Bureau for Economic Research (BER),
expectations increased marginally by 0,1 percentage points in respect of both
2006/07. However, the forecast for 2008 shows a significant upward adjustment
of 0,4 percentage points. The survey results indicate that CPIX inflation is
now expected to average 5,4 percent in both 2007/08. In the previous survey the
forecasts were 5,3 percent and 5,0 percent respectively. Although expectations
for all forecast years are within the inflation target range, the upward trend
in expectations observed over the past two quarters is a source of some concern
to the MPC.
The yield curve became more inverted in October and November 2006. Rather
than necessarily reflecting expectations of a drastic slowing in the economy,
technical factors are partly responsible for the inversion of the curve. The
shorter end of the curve reflects expectations of higher interest rates while
the longer end of the curve is influenced by amongst others, demand and supply
conditions in the bond market and positive expectations regarding future
inflation outcomes.
Notwithstanding the slight improvement in the forecast, the MPC still views
the risks to the outlook to be on the upside with continued pressures on
inflation emanating from a number of sources.
There is a mixed picture with respect to the responsiveness of household
consumer demand to the cumulative 150 basis point increase in the repo rate
since June. The growth in household consumption expenditure declined moderately
from 7,8 percent in the second quarter of 2006 to 7,2 percent in the third
quarter with a marked decline in the growth of spending on durable and
non-durable goods. Motor vehicle sales trends may indicate a possible impact of
the increased interest rates on sales. In November, new motor vehicle sales
increased at a modest year on year rate of 2,3 percent and declined by three
percent on a month on month basis. The First National Bank (FNB) / Bureau for
Economic Research (BER) Consumer Confidence Index, however, rose marginally in
the fourth quarter following a decline in the third quarter indicating
continued resilience in consumer demand.
Despite tentative signs of moderation in consumer demand, private sector
credit extension remains at high levels. Growth in total loans and advances
extended to the private sector has maintained a rate of around 26 percent since
August 2006 despite some securitisation transactions. Mortgage advances
remained the main source of credit growth. The higher rates of credit extension
have contributed to the further increase in household indebtedness which in the
third quarter of this year rose to 73 percent of household disposable income,
while the cost of servicing this debt has also increased marginally.
Insolvencies have remained at low levels.
Food price inflation continues to pose a threat to the inflation outlook and
is likely to maintain its strong trend in the coming months. Wheat and maize
price increases have fed through to food prices at the production price level
and further pass through to CPIX can be expected. Prices of grain products in
CPIX have increased further and in October grain product inflation had risen to
5,5 percent. The futures prices of maize suggest that some respite could be on
the way during the first half of next year.
The risk to the inflation outlook arising from oil price developments
appears to have abated somewhat. For most of October and November, North Sea
Brent crude oil traded at prices between US$55 to US$60 per barrel in the
international market. Towards the end of November prices began to edge up amid
fears of further Petroleum Export Countries (OPEC) quota cuts. The oil prices
displayed a far lower degree of volatility than was the case during the earlier
parts of this year. The current international oil price levels and the more
recently appreciated rand exchange rate have led to a R1 14 per litre decline
in domestic petrol prices during the past four months. Nevertheless the oil
price is still considered to pose an upside risk to the inflation outlook,
given the sensitivity of oil prices to geopolitical events and the continued
tight supply and demand conditions in the oil market.
During the period since the previous meeting of the MPC, the exchange rate
of the rand has displayed a degree of volatility. The related uncertainty
therefore also poses a risk to the inflation outlook. The rand is currently
trading at around R7 10 to the US dollar compared to R7 70 at the time of the
October meeting of the MPC. Part of the recent appreciation of the rand against
the US dollar can be attributed to the recent 6 percent decline in the value of
the US dollar against the euro and pound sterling. Against the euro, the rand
is currently trading at levels similar to those at the previous MPC meeting. On
a trade weighted basis, the rand has therefore appreciated by about 2,8 percent
since 12 October.
Balance of payments developments indicate that the deficit on the trade
account narrowed in the third quarter of this year and has contributed to the
decline in the ratio of the current account deficit to GDP from a revised 5,7
percent in the second quarter of 2006 to 5,2 percent in the third quarter. The
current account deficit continues to be adequately financed by capital inflows
which are largely attracted by the positive growth prospects of the South
African economy. This year up to date, non-resident purchases of South African
bonds and equities have exceeded R100 billion compared to R41 billion for 2005
as a whole. Official gross gold and other foreign exchange reserves stood at
US$25 billion at the end of November 2006 and the international liquidity
position amounted to US$22,2 billion.
The South African economy has sustained its strong growth momentum and grew
at revised annualised rates of 5,0 and 5,5 percent in the first two quarters of
this year respectively. Growth in the third quarter, however, moderated to 4,7
percent. This decline is not viewed as being indicative of a widening of the
output gap and there are few signs of significant underutilisation of capacity
in the economy. The forward looking indicators also remain favourable. The
Investec/BER Purchasing Managers Index declined in November but nevertheless
still indicates a strong performance in the manufacturing sector. Similarly, in
the fourth quarter of this year the RMB/BER Business Confidence Index remained
at the high levels seen over the past two years, while the BER manufacturing
survey showed a marked improvement in manufacturing business confidence in the
fourth quarter of this year.
On the positive side from an inflation outlook perspective, wage settlement
levels appear to be moderate although there is evidence of a slight upward
trend. According to Andrew Levy Employment Publications, the average level of
wage settlements in collective bargaining agreements increased marginally from
6,2 percent in the nine months ending September 2005 to 6,4 percent over the
same period in 2006. Settlements ranged from 4,6 percent in the retail sector
to 8,9 percent in the mining sector. These settlements remain in line with the
inflation target if allowance is made for a moderate increase in labour
productivity over time.
Fiscal policy continues to be supportive of monetary policy. In the October
Medium Term Budget Policy Statement, the government has continued to
demonstrate its commitment to prudent fiscal management.
International inflation developments are generally seen to be relatively
favourable. Global inflation fears appear to have subsided somewhat in the wake
of tighter monetary policies by a number of central banks. However, in recent
weeks there have been indications of a possible slowdown in the US economy
which have contributed to the uncertainties and volatility in the international
financial markets. It is still too early to tell how these developments will
play themselves out in the coming months.
Monetary policy stance
The MPC has decided to adjust the existing monetary policy stance by
increasing the repo rate by 50 basis points to 9,0 percent per annum with
effect from Friday, 8 December 2006. As always the MPC will continue to monitor
all relevant developments in the economy and will not hesitate to act to ensure
that the monetary policy stance remains consistent with achieving the inflation
target.
Contact:
Samantha Henkeman
Tel: (012) 313 4669
E-mail: Sam.Henkeman@resbank.co.za
Issued by: South African Reserve Bank
7 December 2006
Source: South African Reserve Bank (http://www.reservebank.co.za/)
