By CentralBankNews.info
South Africa’s central bank raised its benchmark repurchase rate by a further 25 basis points to 6.25 percent to prevent a rise in inflation expectations and more generalised inflation in light of growing downside risks from persistent exchange rate depreciation, higher electricity tariffs and a rise in food prices from drought.
The South African Reserve Bank (SARB) has now raised its rate by 50 basis points this year and said four members of its monetary policy committee had voted to raise the rate while two members had preferred to retain the policy stance.
“Complicating the decision was the deteriorating economic outlook,” SARB Governor Lesetja Kganyago said, adding that the risks to the outlook were now considered to be on the downside while they were more of less balanced at the previous meeting in September.
While changes to SARB’s forecast for inflation was only minor, Kganyago underlined that the upside risks were now more pronounced and expected to outweigh the possible downside risks from lower global oil prices and a subdued pass-through of changes to the exchange rate.
“While these factors cannot be dealt with directly through monetary policy, the concern of the Committee is that failure to act could cause inflation expectations to become unanchored and generate second-round effects and more generalized inflation,” he said.
Despite the rate rise, SARB still considers its policy stance to be accommodative and future actions will continue to focus on anchoring inflation within the bank’s 3-6 percent range while remaining sensitive to the fragile state of the country’s economy.
The forecast for headline inflation this year was trimmed to 4.6 percent from a previous forecast of 4.7 percent and the forecast for core inflation was unchanged at 5.5 percent.
For 2016 inflation was seen at 6.0 percent, down from 6.2 percent and core inflation at 5.5 percent, up from 5.4 percent. For 2017 headline inflation was forecast at an unchanged 5.8 percent and core inflation at 5.4 percent, up from 5.3 percent.
Headline inflation in October was 4.7 percent, up from 4.6 percent in September.
The forecast for Gross Domestic Product growth in 2015 was trimmed to 1.4 percent from 1.5 percent and 1.5 percent for 2016 from 1.6 percent. For 2017 GDP was forecast to expand by an unchanged 2.1 percent.
In the second quarter of this year, South African’s GDP grew by an annual rate of 1.2 percent, down from 2.1 percent in the first quarter.
The Rand has been on a weakening trend since mid-2011 when it was above 7 to the U.S. dollar. The rand has experienced volatile trading in recent years, not only due to expectations about U.S. monetary policy but also domestic factors, such as labor unrest.
Since the last meeting by the central bank’s monetary policy committee in September, the rand has depreciated 3 percent against the dollar and today it was trading at 14.12 to the dollar, down 17.8 percent this year alone.
“As before, the extent to which Fed tightening has been priced into the exchange rate remains uncertain,” SARB said, adding that volatility and overshooting of the exchange rate is likely ahead of and in the immediate aftermath of any change to U.S. rates.
The latest inflation forecast of the Bank shows a slight near-term improvement, while the medium-term forecast is marginally higher. Inflation is now expected to average 4,6 per cent in 2015, and 6,0 per cent and 5,8 per cent in the next two years. The anticipated breach of the upper end of the target range in the first quarter of 2016 is now expected to average 6,4 per cent, compared with 6,7 per cent previously. The trajectory for the rest of the year is also slightly lower than previously forecast, with the temporary breach in the fourth quarter of 6,1 per cent. The forecast for 2017 follows a slow downward trend, with inflation still expected to measure 5,7 per cent in the final quarter. The changes in the forecast are due to a lower starting point for the forecast, lower international oil price assumptions, and an adjustment to fees for higher education which are more or less offset by a more depreciated starting point for the real effective exchange rate.
Russia and Brazil remain in recession, while the strong performance of the Indian economy has been sustained following a number of structural reforms. The outlook for sub-Saharan Africa, while still positive, has deteriorated in the wake of lower commodity prices, and further weakening could create greater headwinds for South African manufactured exports to this region.
Although volatility in global asset markets has moderated amid improving risk sentiment, emerging market foreign exchange markets have been relatively volatile and vulnerable to capital outflows. In the past three months South Africa has also seen net portfolio outflows: since the end of August, according to the JSE data, non-resident sales of equities amounted to R25,9 billion, while net bond sales amounted to R5,9 billion.
The manufacturing sector recovered somewhat in the third quarter, mainly due to a surprisingly strong performance in September, and is expected to have contributed positively to GDP growth. However, the Barclays PMI declined further in October, and has been below the neutral level of 50 for three consecutive months, suggesting a constrained outlook for the sector. The mining sector is expected to subtract from GDP growth following a further contraction in the third quarter, while the continuing drought points to a third successive quarterly contraction for the agricultural sector. The outlook for the construction sector is constrained following significant declines in new building plans passed, and reflected in a 9 point drop in the FNB/BER Building Confidence Index.
Consumption expenditure is also constrained by the continued slow growth in credit extension to households by banks. Unsecured lending remains subdued, and is likely to be impacted further by the recently announced caps on interest rates by the DTI, while the decline in growth in instalment sale credit and leasing finance is indicative of the softer motor vehicle sales. Credit extension to corporates remains robust, particularly commercial mortgage finance, which reflects in part a switch away from funding in the bond market by property funds.
A higher food price trajectory has been incorporated in the forecast for some time, but food price inflation has surprised on the downside in recent months, despite sharp increases in maize and cereals prices earlier in the year. However, the increased intensity of the drought which has led to downward revisions of the domestic maize crop estimate, as well as incipient pressures evident in both the PPI and CPI, suggest that an acceleration in food price inflation is likely, adding to the upside risk to the inflation outlook.
Although the inflation forecast is relatively unchanged since the previous meeting, the upside risks to the inflation outlook are more pronounced. As noted, these risks relate to the persistent exchange rate depreciation, electricity tariffs and food prices, and are assessed to outweigh possible downside risks from lower international oil prices and subdued exchange rate pass-through. While these factors cannot be dealt with directly through monetary policy, the concern of the Committee is that failure to act could cause inflation expectations to become unanchored and generate second-round effects and more generalised inflation. Although core inflation has remained steady and inflation expectations to date have been relatively anchored, they remain at uncomfortably elevated levels.
Despite the increase, the MPC still views the monetary policy stance to be accommodative. The continuing challenge is for monetary policy to achieve a fine balance between achieving our core mandate of price stability and not undermining short-term growth unduly. Monetary policy actions will continue to focus on anchoring inflation within the target range while remaining sensitive, to the extent possible, to the fragile state of the economy. As before, any future moves will therefore be highly data dependent.”