African Reserve Bank Governor, Mr T T Mboweni
12 April 2007
Since the previous meeting of the Monetary Policy Committee (MPC) in
February 2007, the inflation outlook has deteriorated somewhat, despite the
most recent inflation outcomes. The less favourable outlook has been brought
about primarily by petrol and food price increases. Domestic demand pressures
and credit extension have remained strong with only tentative signs of
moderation in response to the tighter monetary policy stance.
At the same time, the South African economy has been growing at a robust
pace and employment growth has also been encouraging. Domestic growth prospects
remain positive despite the temporary sell-off in the international markets in
late February. The appetite for emerging market assets has rebounded
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 5,3 percent in January 2007,
following a rate of increase of 5,0 percent in the previous three months. In
February, year-on-year CPIX inflation declined to 4,9 percent. Food and energy
remained the main drivers of inflation. If these categories were excluded, CPIX
inflation would have measured 3,9 percent and 4,0 percent in January and
February respectively.
Food prices increased at a year-on-year rate of 7,7 percent in February this
year, following an 8,1 percent increase in January. Meat price inflation, which
was the largest contributor to overall CPIX inflation, declined from 16,0
percent in January to 13,9 percent in February. The elevated spot prices of
maize and wheat resulted in grain product prices accelerating at a rate of 8,7
percent in February, compared to 7,1 percent in January. Petrol price changes
over the past few months have been a reflection of the volatility in
international oil prices and the exchange rate. In February 2007, year-on-year
petrol price inflation measured 1,8 percent compared to 8,2 percent the
previous month. This is nevertheless significantly lower than the increases in
excess of 20 percent that were experienced in the middle of last year. In
contrast, the prices of a number of goods continued to decline in February.
Clothing prices declined by 7,8 percent, footwear prices by 11,0 percent and
those of furniture by 2,8 percent.
In January and February 2007, goods price inflation measured 5,7 percent and
5,0 percent respectively, compared to services price inflation of 4,6 percent
and 4,8 percent in the same months. Administered prices increased by 6,4
percent and 4,1 percent in January and February respectively while administered
prices excluding petrol increased at a year-on-year rate of 5,7 in those
months, compared to 3,1 percent in June 2006.
Production price inflation continued to increase at high rates, across a
broad range of categories, although below the peak of 10,0 percent seen in
October and November 2006. Measured year-on-year, production price inflation
declined to 9,5 percent in February, compared to 9,8 percent in January.
Imported goods inflation measured 9,7 percent in February compared to
domestically produced goods inflation of 9,4 percent.
The outlook for inflation
The most recent central forecast of the Bank's forecasting model indicates
deterioration in the inflation outlook, mainly as a result of adverse
developments in the international oil markets and administered prices. The
forecast, which takes account of the petrol price increases of March and April,
projects that CPIX inflation will increase to slightly below the upper level of
the inflation target in the second quarter of 2007. Thereafter, apart from a
technical decline in the third quarter, CPIX inflation is expected to remain at
rates of around 5,9 percent until the second quarter of 2008 and then follow a
downward trajectory to reach five percent by the final quarter of that
year.
The latest survey of inflation expectations conducted on behalf of the Bank
by the Bureau for Economic Research (BER) at the University of Stellenbosch
indicates that CPIX inflation expectations in respect of both 2007 and 2008
have declined compared to the previous survey. This may indicate that inflation
expectations are not always backward looking, and have remained entrenched
within the inflation target range. Inflation expectations declined from 5,4
percent to 5,2 percent for 2007, and from 5,4 percent to 5,1 percent for 2008,
while CPIX inflation is expected to average 5,1 percent in 2009. All categories
of respondents lowered their expectations for 2007, while business executives
and trade union officials lowered their expectations for 2008.
As usual, the MPC analysed the factors impacting on inflation and assessed
the risks to the forecast. In some instances, these risks were perceived to
have increased, whereas in other cases there has been no major change to our
previous assessment. In particular, the risks posed by oil and food prices
appear to have increased.
International oil price developments have been dominated by heightened
geopolitical tensions, supply disruptions and declining inventory levels. The
price of North Sea Brent crude oil increased to around 70 dollar per barrel in
recent weeks, compared to a level of around 56 dollar per barrel at the time of
the February MPC meeting. As a result, the domestic petrol price increased by
R0,24 per litre in March, and R0,68 per litre in April. A decomposition of the
April price increase shows that of the R0,68 increase in April, about R0,09 was
attributable to exchange rate changes, R0,10 to fuel taxes announced in the
February budget, and the remainder to changes in the international price of
oil. International oil prices are expected to remain vulnerable to geopolitical
developments and therefore continue to pose a significant risk to the
outlook.
The spot prices of white and yellow maize have increased significantly over
the past two years as a result of domestic drought conditions and increases in
international prices. Grain product prices, which have a weight of 4,8 percent
in CPIX, are expected to increase further as they have not yet fully reflected
these increases. The higher maize prices have also affected meat prices through
their impact on cattle and chicken feed prices. However, meat price inflation
could be moderated somewhat as more cattle are brought to market during periods
of drought. This effect, while possibly significant, is expected to be
relatively short-lived.
Despite the tighter monetary stance since June last year, household
consumption expenditure growth, which measured almost eight percent in the
fourth quarter of 2006, continues to pose a risk to inflation. In January of
this year, retail sales increased at a year-on-year rate of 9,4 percent
compared to 6,7 percent in December 2006. There is, however, some evidence of
moderation in the growth of interest sensitive durable goods consumption. In
particular, a softening trend in motor vehicle sales has been observed in
recent months. The seasonally adjusted number of new vehicles sold in the first
quarter of 2007 declined by 2,9 percent compared to the fourth quarter of
2006.
Consumer confidence remains at a high level. According to the latest First
National Bank (FNB) / Bureau for Economic Research (BER) Consumer Confidence
Index (CCI), the CCI increased significantly during the first quarter of 2007,
to reach the highest level ever recorded in the 25 year existence of the index.
Factors underpinning the strong demand include the further increases in asset
prices. The housing market remains buoyant and the Johannesburg Stock Exchange
(JCC) Securities Exchange has reached new highs despite the short-lived
downturn in March.
Credit extension by banks to the private sector has continued at
uncomfortably high levels. Twelve month growth in banks' loans and advances
extended to the private sector has grown at a rate of around 27 percent since
November 2006, and increased to 27,7 percent in February this year. Asset
backed credit growth however showed a modest decline in February to 25,5
percent. Instalment sale and leasing finance growth declined from 15,8 percent
in December to 14 percent in February, reflecting the moderation in demand for
motor vehicles. Growth in total loans and advances to households has been on a
somewhat declining trend compared to the strong upward trend in credit
extension to the corporate sector. Nevertheless, the ratio of household debt to
disposable income increased further in the fourth quarter of 2006 to almost 74
percent and the cost of servicing the debt has been steadily increasing.
The South African economy has grown at a rate of 5 percent in each of the
past three years, a level which we estimate to be slightly above potential.
Indications are that growth rates around this level are likely to be sustained
during 2007. Capacity utilisation in the manufacturing sector increased further
in the fourth quarter to a new level of 86,6. The Investec Purchasing Managers
Index (PMI) reflects continued buoyant conditions in the manufacturing sector,
and despite a marginal decline in the RMB Business Confidence Indicator,
business confidence remains high and broad-based.
Underpinning this positive outlook is a strong trend in the growth of
investment expenditure. Gross fixed capital formation increased at an
annualised rate of 16,6 percent in the fourth quarter of 2006, and 12,8 percent
for the year. As a ratio to Gross Domestic Product (GDP), gross fixed capital
formation has increased from around 15 percent in the early part of the decade
to over 19 percent in the final quarter of 2006. While this bodes well for
current and future growth, the concurrent decline in the savings ratio has seen
the current account deficit of the balance of payments widening to 6,4 percent
of GDP in 2006, and 7,8 percent of GDP in the final quarter of the year.
The good growth prospects for the economy continued to ensure that the
current account deficit has been adequately financed. Since the beginning of
this year, net non-resident purchases of bonds and equities have totalled R20,3
billion. The Bank has also been able to continue with its gradual build-up of
international reserves. Official gross gold and other foreign exchange reserves
stood at 26,5 billion dollars at the end of March 2007 and the international
liquidity position amounted to 24,0 billion dollar.
Since the February meeting of the MPC, the exchange rate has been relatively
stable, apart from the reaction to the transitory sell-off in international
financial markets in late February. The exchange rate reached a level of R7,55
to the United State (US) dollar in response to the heightened risk in the
markets, but by late March the rand had returned to levels below R7,30. The
rand is currently trading at around R7,15 to the US dollar, compared to R7,20
at the previous meeting. The trade-weighted rand exchange rate is also
relatively stable compared to February. Other factors impacting on the exchange
rate during this period included movements in the US dollar against other
currencies and commodity price fluctuations.
The outlook for global growth appears to be positive, despite the recent
market volatility. The re-rating of risk, particularly in emerging markets,
resulted in significant adjustments in exchange rates and stock market
valuations globally. Most markets have since recovered to a large extent,
including those in South Africa. Strong growth in most regions is expected to
be sustained, although there is the risk of a slowdown in the United States.
The continued resilience of the world economy also bodes well for commodity
prices. Global inflation is expected to remain under control despite the firmer
oil prices, and the international interest rate cycle appears to have peaked.
However, monetary policies are unlikely to become generally more accommodating
in the short term in the face of the positive growth outlook.
Monetary policy stance
The Monetary Policy Committee has decided that despite the slight
deterioration in the inflation outlook, an unchanged monetary policy stance
continues to be appropriate for now. The repo rate will therefore remain at
nine percent per annum.
Enquiries:
Thandi Moya
Cell: (012) 313 3027
Issued by: South African Reserve Bank
12 April 2007
Source: South African Reserve Bank (http://www.reservebank.co.za)
