African Reserve Bank Governor, Mr TT Mboweni
15 February 2007
Introduction
Since the meeting of the Monetary Policy Committee in December 2006, the
outlook for inflation has on balance improved. Inflation outcomes, with respect
to both consumer and producer prices, have been below expectations, mainly as a
result of moderating food price inflation and lower international oil prices.
Nevertheless, some longer-term risks to the outlook remain. There are still
only tentative signs that consumer demand growth is abating. Credit extension
has continued to grow at a robust rate. The challenge for monetary policy is to
weigh up the perceived medium to long-term risks against the more favourable
outlook. In the past few meetings, the MPC has consistently seen these risks to
be firmly on the upside.
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) has remained constant at 5,0 percent for the three months to
December of 2006. In 2006 as a whole, CPIX inflation averaged 4,6 percent
compared to 3,9 percent in 2005. In December, goods price inflation was
unchanged from November at 5,2 percent, while services price inflation
increased to 4,8 percent from 4,6 percent in November driven mainly by higher
rates of increase in housing services and medical services.
Food price inflation which has been a major driver of CPIX inflation over
the past few months has shown some signs of moderation. In December, food price
inflation measured 7,7 percent, compared to the peak of 9,4 percent in October
2006. Meat prices, which remain the main contributor to food price inflation,
increased by 16,6 percent in December compared to rates of increase of just
below 20 percent in the previous two months. The petrol price increased at a
year-on-year rate of 5,8 percent in December, despite the R0,07 price decrease
in that month. Prices of clothing and footwear fell by almost 12 percent in
December compared to the previous year.
Production price inflation also shows signs that it may have peaked. Having
measured 10,0 percent in both October and November 2006, production price
inflation declined to 9,3 percent in December. Imported goods inflation
measured 9,1 percent compared to domestically produced goods inflation of 9,4
percent. The contribution of food to production price inflation moderated in
December which suggests that pressure on food prices at the consumer level
could be further contained.
The outlook for inflation
The most recent central forecast of the Bank's forecasting model indicates
an improvement in the inflation outlook compared to the forecast considered at
the December meeting of the Monetary Policy Committee. CPIX inflation is no
longer expected to breach the upper end of the target, but is now expected to
peak at an average rate of around 5,6 percent in the second quarter of this
year and to average 4,7 percent by the fourth quarter of 2008. In terms of the
model, the improved outlook is primarily the result of the change in the
monetary policy stance last year and the improved outlook with regard to
expected international oil price developments.
There are a number of additional developments contributing to this positive
outlook. There is some evidence of an improvement in market expectations of
inflation since the last MPC meeting. The yield curve has inverted further,
reflecting in part an improvement in inflation expectations. The break-even
inflation rates as suggested by the yield differential between inflation-linked
bonds and conventional government bonds indicate that inflation expectations
have improved significantly since September when yields at shorter maturities
exceeded 6 percent. Since then, break-even inflation rates across all
maturities have declined.
Inflation expectations are also reflected to some extent in wage settlements
in the economy. Recent nominal wage developments are indicative of inflation
expectations remaining under control despite a slight upward trend. In the
third quarter of 2006, unit labour costs increased at a year-on-year rate of
5,3 percent, compared to a second quarter increase of 3 percent. According to
Andrew Levy Employment Publications, nominal wage settlements averaged 6,5
percent in 2006 compared to 6,3 percent in 2005. Although wage settlements were
slightly higher in 2006, the inflation rate was higher than in the previous
year. If allowance is made for a moderate increase in labour productivity,
these increases are consistent with the inflation target.
The domestic economy shows signs that the growth momentum has been
maintained at rates around potential. Capacity utilisation levels remain high,
particularly in construction and electricity generation, although they are
below the peak reached in the second quarter of 2006. Growth in the mining and
manufacturing sectors continued to display upward trends in 2006. Seasonally
adjusted total mining production increased by 5,5 percent in the three months
ending December 2006, compared with the previous three months, while
manufacturing sector output increased by 2,1 percent over the same period. The
positive trend in manufacturing is expected to be sustained as reflected in the
Investec-BER Purchasing Managers Index which reached a level of 57,2 in January
2007.
The exchange rate of the rand has been relatively stable and averaged R7,14
to the United States (US) dollar since the last MPC meeting when it was trading
at around R7,10. During this period, it fluctuated in a range of between R6,93
and R7,40 to the US dollar. The rand is currently trading at around R7,20. On a
trade-weighted basis, the rand is relatively unchanged since the last meeting.
Much of the volatility observed since the previous meeting has been due to
movements of the US dollar against other currencies, fluctuations in commodity
prices and generally illiquid conditions in the local foreign exchange market
at the end of the year.
Balance of payments developments suggest that the deficit on the current
account might have widened significantly in the fourth quarter of 2006
following an increase in the trade deficit. Preliminary estimates indicate that
the deficit on the trade account of the balance of payments more than doubled
from the third to the fourth quarter of 2006. In the fourth quarter, the value
of merchandise imports increased by about 17 percent from the third quarter,
while the value of merchandise exports increased by about 8,5 percent. Much of
the import momentum in the fourth quarter, however, can be ascribed to the 140
percent increase in the volume of oil imports compared to the third quarter.
This inventory build-up appears to be exceptional and oil imports are unlikely
to be sustained at these levels.
We have emphasised on a number of occasions that the MPC does not have a
target for the current account, nor does the MPC view deficits on the current
account to be inflationary in themselves. The mandate of the bank is to
maintain inflation within the target range of 6 to 3 percent. The risk to
inflation arises if the market perceives a particular level of the current
account to be unsustainable, which could have implications for the exchange
rate and consequently for the inflation rate. To date the current account
deficit, including that in the fourth quarter, has been adequately financed.
Current developments appear to indicate that the current account deficit will
continue to be adequately financed given the coherent macroeconomic policy
framework of the country and positive growth prospects. Non-resident purchases
of South African bonds and equities totalled R108 billion in 2006 as a whole,
compared to R41 billion for 2005. This year to date, the non-residents have
been net buyers of bonds and equities to the value of around R5,1 billion.
Official gross gold and other foreign exchange reserves stood at US$25,9
billion at the end of December 2006 and the international liquidity position
amounted to US$23,3 billion.
Fiscal policy has remained supportive of monetary policy. International
factors also provide a benign backdrop to the inflation outlook. Global growth
prospects generally remain positive, with most regions expected to experience
sustainable growth rates. The global interest rate cycle appears to have peaked
in most regions and world inflation is expected to remain under control.
International oil price developments have impacted positively on inflation
outcomes. The price of North Sea Brent crude oil, which was above US$62 per
barrel at the time of the December meeting, reached a 20-month low of around
US$51 per barrel in January following the unseasonably warm winter in the
northern hemisphere. However a further reduction in output quotas by
Organisation of Petroleum Exporting Countries (OPEC), effective from Thursday,
1 February 2007 and colder weather in Europe and the US resulted in prices
rising back towards US$60 per barrel. In the past few days the price of Brent
crude has declined to around US$56 per barrel as fears of further OPEC cuts
abated.
Domestic petrol prices increased by R0,06 per litre in January, but were
reduced by R0,23 cents per litre in February. This recent relative stability in
the oil market has reduced the risk posed to inflation from this source.
Nevertheless, given the tight supply and demand conditions in the market, oil
prices remain vulnerable to geopolitical developments.
As has been the case in the past few meetings, the central concern of the
MPC was the continued strong pace of household consumption expenditure growth
and its potential impact on inflation. It is recognised that there are lags in
the adjustment to interest rate changes and the question facing the Committee
was the extent to which further reactions to interest rate changes can still be
expected.
This is a difficult judgement call to make in the light of the inevitable
lags in data collection. Consumer demand, however, still appears to be growing
robustly despite the 200 basis point increase in the repo rate last year. Real
retail sales growth increased at a year-on-year rate of 12,3 percent in
November but moderated somewhat to 7,2 percent in December. On a seasonally
adjusted month-on-month basis a decline of 2,1 percent was recorded. It is
still premature to tell whether this is the beginning of a new trend. There are
also tentative signs that demand for motor vehicles may be declining.
Household consumption expenditure has been underpinned by the continued
asset price growth which has contributed to the sustained strength in household
balance sheets. Share prices on the Johannesburg Securities Exchange (JSE)have
continued to reach new highs. The All-share Index increased by 38 percent
during 2006 and since the last meeting of the MPC has increased by 9 percent.
House prices have also continued to increase at a brisk pace. According to the
Absa house price index, house prices are still growing at year-on-year rates of
almost 15 percent.
Twelve-month growth in banks' loans and advances extended to the private
sector increased by almost 28 percent in December, although the annualised
quarterly growth showed some sign of moderation, declining from 28,6 percent in
the third quarter to 26,6 percent in the fourth quarter. Mortgage advances grew
at rates of around 30 percent for much of 2006, while instalment sale credit
and leasing finance recorded year-on-year growth of 15,8 percent in December.
These increases were despite further securitisation transactions on the part of
the banks. Of significance is the fact that growth in total loans and advances
to the corporate sector increased from 27,6 percent in October to 31,8 percent
in December, whereas growth of credit extended to the household sector declined
from 26,1 percent in October to 24,3 percent in December.
Monetary policy stance
On the basis of the foregoing analysis, the Monetary Policy Committee is
satisfied that the inflation outlook has improved somewhat and expects
inflation to remain within the target range for the forecast period. As the
mandate of the bank is to keep inflation within the inflation target range, the
Monetary Policy Committee has decided to leave the repo rate unchanged for now
at 9 percent per annum. However, risks to the inflation outlook remain and the
MPC will continue to closely monitor developments with a view to adjusting the
monetary policy stance as and when required.
Enquiries:
Samantha Henkeman
Tel: (012) 313 4669
E-mail:Sam.Henkeman@resbank.co.za
Issued by: South African Reserve Bank
15 February 2007
Source: South African Reserve Bank (http://www.reservebank.co.za)
