South Africa’s central bank left its benchmark repurchase rate at 7.0 percent as it “felt that there was some room to pause in this tightening cycle” due to an improved outlook for inflation, but added that if “will not hesitate to act appropriately should the inflation dynamics require a response.”
The South African Reserve Bank (SARB) has raised its rate by 200 basis points since January 2014, including 75 points this year and said five members of its monetary policy committee voted to maintain the policy rate today while one member preferred to raise it by another 25 points.
Past rate hikes, including a 25-basis-point rate hike in March, helped improve the outlook for inflation but the central bank’s monetary policy committee again underlined its sensitivity to economic growth which continues to disappoint.
“While there are signs that the economy may be reaching the low point in the growth cycle, the recovery is expected to be slow with downside risks,” SARB Governor Lesetja Kganyago said.
South Africa’s Gross Domestic Product expanded by only 0.6 percent in the fourth quarter of 2015 from the same 2014 period and SARB said recent data painted “a particularly bleak picture” of the first quarter of this year as mining output contracted, growth in the manufacturing sector was “minimal” and electricity output and consumption declined.
SARB revised downwards its 2016 growth forecast to 0.6 percent from 0.8 percent. While growth is expected to improve over the next two years, it still revised downward its forecast for 2017 and 2018 by 0.1 percentage point to 1.3 percent and 1.7 percent, respectively.
South Africa’s consumer price inflation rate eased to 6.2 percent in April from 6.3 percent in March and 7.0 percent in February, but the bank’s measure of core inflation – which excludes food, fuel and electricity, rose to 5.5 percent in April from 5.4 percent in March.
“While the impact of the weaker exchange rate remains relatively low, there are indications of increased pass-through in some categories, particularly new motor vehicles and appliances,” Kganyago said.
The bank’s latest inflation forecast shows a slight deterioration in the near term, but some improvement in the medium term, the bank said, adding that inflation is now expected to average 6.7 percent this year, slightly below the 6.7 percent forecast previously.
Inflation is seen peaking at 7.3 percent in the fourth quarter of this year and then average 6.2 percent in 20-17 and 5.4 percent in 2018, marginally below previous forecasts due to assumptions of higher interest rates, a slightly higher exchange rate, a wider output gap and lower electricity prices.
SARB, which targets inflation of 3.0 to 6.0 percent, added that the forecast for inflation for this year was lowered to 5.9 percent from 6.2 percent but the forecasts for 2017 and 2018 were unchanged at 5.7 percent and 5.2 percent, respectively.
After steadily depreciating since mid-2011 and hitting historic lows in January, South Africa’s rand bounced back in the first four months of this year on higher commodity prices, a narrower trade balance and expectations of a slower pace of U.S. rate hikes.
However, since the start of May, when global growth concerns again surfaced, it has resumed its fall and was trading at 15.86 to the U.S. dollar today, down 2.1 percent this year.
The latest inflation forecast of the Bank shows a moderate near-term deterioration compared with the previous forecast, but there is some improvement in the medium- term outlook. The breach of the upper end of the target range, while still protracted, is now slightly shorter, with inflation expected to fall within the range during the third quarter of 2017. Inflation is now expected to average 6,7 per cent in 2016 compared with 6,6 per cent previously. In 2017 and 2018 inflation is expected to average 6,2 per cent and 5,4 per cent, marginally down from the previous forecast. The expected peak, at 7,3 per cent in the fourth quarter of 2016, is unchanged. The downward revisions are due in part to the higher interest rate assumption, a slightly less depreciated exchange rate assumption, a wider output gap and a lower electricity price assumption. These pressures are counteracted to some extent by a higher near-term food price forecast, and the impact of upward revisions to the international oil price assumptions.
Global growth remains hesitant following a disappointing first quarter in the US and the UK in particular. While labour market conditions in the US have improved, low corporate profits have constrained investment. However, consensus forecasts show that a moderate improvement is expected in the coming months, but at a lower rate than previously expected. The outlook for the UK is clouded by the possibility of an exit from the EU, while the prospects for the Japanese economy remain uncertain. By contrast, the growth outlook in the euro area is more promising, driven by improvements in Germany and France in particular, although there are concerns that the recent momentum may be fading.
The domestic economic growth outlook remains weak, with the Bank’s GDP growth forecast for 2016 revised down from 0,8 per cent to 0,6 per cent. While a recovery is still expected in the next two years, the forecasts for both these years have been revised down by 0,1 percentage point to 1,3 per cent and 1,7 per cent. With the estimates of potential output unchanged, the output gap is expected to widen over the forecast period. The Bank’s leading indicator of economic activity continued its downward trajectory in February, consistent with the constrained outlook.
Household consumption expenditure also remains subdued, with low growth in retail sales in the first quarter. While there was a welcome increase in exports, new vehicle sales also continue to decline. The FNB/BER consumer confidence index recovered to some extent in the first quarter of the year, although it still remains at depressed levels, and indicates a low willingness to spend and utilise credit among consumers.
Food prices remain a significant risk to the inflation outlook in the face of persistent drought and exchange rate weakness. These pressures are evident in both the consumer price and producer price indices. Although for some time the MPC had been expecting an acceleration in food price inflation, the recent increases have surprised on the upside, and more aggressive food price increases are now forecast for the near term. The Bank now expects food price inflation to peak at around 12 per cent in the final quarter of this year. However, should food prices stabilise or decline later in the year, there is the potential for downside base effects next year. Futures prices suggest that both maize and wheat prices are expected to remain elevated for the rest of the year, reinforced by a sizeable increase in the domestic wheat import tariff.
The Committee remains concerned about the inflation outlook and the extended breach of the target. Although the inflation forecast has shown a moderate improvement over the medium term, the risks are still assessed to be on the upside. The exchange rate remains highly sensitive to domestic political developments and risks of an earlier-than-expected tightening in US monetary policy. The exchange rate implicit in the forecast is stronger than the current level, imparting a significant degree of upside risk. While pass-through from the exchange rate to inflation remains relatively subdued, there are indications that this may be increasing. There is also some upside risk to the international oil price assumption.
The MPC remains focused on its inflation mandate, but sensitive to the extent possible to the state of the economy. The MPC will not hesitate to act appropriately should the inflation dynamics require a response, within a flexible inflation targeting framework. Future moves, as before, will continue to be highly data dependent.”
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