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Statement of the Monetary Policy Committee
by Governor of the South African Reserve Bank, Mr TT
Mboweni, 12 August 2004
Introduction
The inflation outcome during the first six months of
2004 was more favourable than had been thought to be
the case at the previous meeting of the Monetary Policy
Committee. The actual year-on-year increases in the
consumer price index in metropolitan and other urban
areas when mortgage cost is excluded (CPIX) were much
better than forecast. The lower base, combined with
the recent rise in the value of the Rand, has resulted
in a lower projection for CPIX inflation in the next
two years. Although CPIX inflation is still expected
to rise over the forecast period, it will probably not
breach the upper 6 per cent level of the target range,
as previously concluded, provided that the assumptions
made in the projection are not too wide off the mark.
These results are expected to be achieved in combination
with robust growth rates in domestic production as well
as demand.
The inflation outcome
The twelve-month rate of increase in the CPIX rose
from 4,0 per cent in December 2003 to 4,8 per cent in
February 2004, before slowing down to 4,4 per cent in
March and remaining at that level in the next two months.
In June 2004 CPIX inflation rose to 5,0 per cent mainly
due to increases in petrol and diesel prices. This was
probably a temporary spike in CPIX inflation because
the prices of petrol and diesel were reduced in the
next two months. If changes in petrol and diesel prices
are excluded from the CPIX, the year-on-year rate of
increase in the prices of other consumer goods and services
continued to slow down from 4,9 per cent in February
2004 to 4,0 per cent in June. CPIX inflation has now
been within the inflation target range for a period
of ten consecutive months.
Measured from quarter to quarter at seasonally adjusted
and annualised rates, CPIX inflation declined from 7,2
per cent in the first quarter of 2004 to 5,2 per cent
in the second quarter. The deceleration in CPIX inflation
was discernible in most of the main categories of consumer
goods and services and the prices of certain products
actually declined, such as those of clothing and footwear,
food and soft drinks, and of new and used vehicles.
In contrast to these developments, the running cost
of vehicles, and the prices of water, education and
alcoholic drinks and tobacco rose at quarterly annualised
rates in excess of 10 per cent. The rates of increase
over twelve months in the prices of these goods and
services and in the cost of medical services were also
still well above the upper limit of the inflation target
range. These high increases were largely due to changes
in administered prices and indirect taxes. However,
recent announcements by the government indicate a greater
determination to moderate increases in administered
prices as part of the co-ordination of policies to achieve
the objective of price stability.
The all-goods production price index declined in the
second half of 2003 to a lower level in January 2004
owing to a decline in the prices of imported goods and
relatively low rates of increase in the prices of domestically
produced goods. From February 2004 this index started
to move upwards, with the result that the all-goods
production price inflation measured over twelve months
became positive in May and amounted to 1,3 per cent
in June. The quarter-to-quarter rate of increase in
production prices, seasonally adjusted and annualised,
rose from 0,2 per cent in the first quarter of 2004
to 4,7 per cent in the second quarter. These recent
increases in production prices are consistent with the
expected rise in consumer prices in the coming months
since consumer prices normally react to changes in the
prices charged by producers with a time lag.
The favourable inflation outcome was at first achieved
with slower growth in the domestic economy. Growth in
real gross domestic product deteriorated in 2003 and
averaged only 2 per cent for the year as a whole. Production
volumes were affected by a hesitant global economic
recovery, deterioration in the international price competitiveness
of domestic manufacturers and a decline in agricultural
output. In the latter part of 2003 growth started to
gather momentum and in the first quarter of 2004 amounted
to a seasonally adjusted annualised rate of 3 per cent
in reaction to a more accommodative monetary and fiscal
policy stance, stronger global growth and increased
business and consumer confidence. Data, such as manufacturing
and mining output, wholesale and retail trade volumes
and the number of new vehicles sold, indicate that the
economy continued to grow briskly in the second quarter
of the year.
The inflation outlook
As already indicated, the inflation outlook is generally
promising and CPIX inflation is expected to stay within
the inflation target range over the next two years,
but it could move close to the upper boundary of the
target range in the second half of 2005. One of the
main factors responsible for the recent and expected
future low inflation is the decline in import prices,
brought about by the further rise in the external value
of the Rand and low global inflation. Import price inflation,
measured over periods of twelve months, has been negative
since April 2003, or for a period of fifteen months.
South African import prices will be influenced, in
the first instance, by global inflation. As could be
expected with the significant increase that has been
experienced in international commodity prices since
the beginning of 2002, consumer price inflation has
started to rise in most of the major industrialised
economies. For example, year-on-year core inflation
in the United States of America increased from 1,1 per
cent in January 2004 to 1,9 per cent in June, and the
corresponding rate of increase in the harmonised index
of consumer prices in the euro area rose from 1,6 per
cent in February 2004 to 2,4 per cent in June. These
increases are, however, coming from low levels. A marked
acceleration in global inflation to high levels is not
foreseen, particularly because of the continued strong
productivity growth in some of these countries combined
with a tightening in the monetary policy stance.
Import price inflation is also dependent, in the second
instance, on the external value of the Rand. Having
recovered during 2002 and 2003 from the sharp fall in
the latter part of 2001, the nominal effective exchange
rate of the Rand increased by a further 9 per cent until
the end of July 2004. This sharp rise in the average
exchange rate of the Rand has distorted the planning
of many enterprises in the country and has had a serious
negative impact on international price competitiveness
with the resultant stress being witnessed in the export
earnings of manufacturing and mining companies. At the
same time, the exchange rate of the Rand has also contributed
to lower imported inflation and, looking forward, to
a lower prospective profile of CPIX inflation within
the target range.
Currency markets are unpredictable and so is the future
performance of the exchange rate of the Rand, which
is, amongst other things subject to balance of payments
developments. South Africa's international trade balance
has declined from a surplus at a seasonally adjusted
annualised rate of about R30 billion in the second quarter
of 2003 to nearly R15 billion in the first quarter of
2004 and a deficit of R5, 5 billion in the second quarter.
However, if special factors affecting the trade balance
are excluded, such as purchases of commercial aircraft
and military equipment, the trade balance has remained
broadly unchanged over the past three quarters. Moreover,
the turnaround to a negative overall trade balance did
not affect the exchange rate of the rand because it
was easily financed by an inflow of capital. The future
external value of the Rand might depend to a large extent
on the behaviour of these financial inflows.
Concern about the influence of another exogenous factor,
food prices, has dissipated somewhat. At the beginning
of 2004 the Monetary Policy Committee noted the severe
drought in many parts of the country, combined with
the rise in global food prices. Widespread rains in
the summer-rainfall area led to upward revisions of
crop estimates, and shortages of maize and other grains
should not negatively affect agricultural prices. Despite
the heavy rains in the winter-rainfall areas, evidence
suggests that some parts are still in the grip of a
drought. The recent reversal in global food prices should
alleviate pressures that could arise from poor agricultural
conditions.
An important positive development on the inflation
front has been the declining trend of inflation expectations
in the country. This is clearly illustrated by the Survey
of Inflation Expectations of The Bureau for Economic
Research at the University of Stellenbosch undertaken
on behalf of the Reserve Bank in the second quarter
of 2004. According to this survey, CPIX inflation expectations
have declined continuously. In contrast to this, the
break-even inflation rate calculated as the difference
between the nominal yield on government bonds and the
real yield on inflation-linked bonds within the five-to-nine
year maturity range has increased in 2004. This approximation
of long-term inflation rose from a low of 4,8 per cent
in December 2003 to 6,1 per cent in May 2004, before
declining to 5,6 per cent recently in July.
A number of other factors support a positive inflation
outlook. These include the low levels of utilisation
of manufacturing production capacity, continued fiscal
prudence and more restraint in administered price increases.
In addition, the twelve-month growth in total loans
and advances extended by banks to the domestic private
sector declined from a peak of 12,6 per cent in February
2004 to 8,9 per cent in June. However, part of this
lower growth is due to disintermediation as the corporate
sector is funding capital outlays and other expenditure
to an increasing extent outside the banking sector.
The most important risks over the short term to this
positive inflation outlook are probably global imbalances,
exchange rate movements and increases in international
oil prices. In particular the rise in oil prices presents
a major threat to inflation over the short term. Brent
crude oil prices have increased from levels of around
US$24 per barrel in May 2003 to almost US$40 per barrel
in May 2004. This rise in international oil prices reflected
mainly ongoing geopolitical tensions in the Middle East
and a strong demand for oil in the United States and
China. Although oil prices declined somewhat in June
2004 to levels of around US$34 per barrel when the OPEC
countries stated that they would increase production,
this did not last long and at present oil prices are
fluctuating around levels of US$42 per barrel. Such
high prices will not only have an impact on inflation,
but could also neutralise to some extent the recent
improvements in the global economy as well as South
Africa's terms of trade and growth.
Over the longer term, the current growth in nominal
unit labour cost could be a significant threat to low
inflation as well. This growth in nominal unit labour
cost rose from an average of 5,0 per cent in 2003 to
a year-on-year rate of 5,9 per cent in the first quarter
of 2004.
Another development, which could have an impact on
inflation over the long term, is the higher rate of
increase in domestic demand reflecting the reduction
in interest rates, rising real disposable income and
the higher priority assigned to infrastructural development.
National accounts statistics are not yet available for
the second quarter of 2004, but available indicators,
such as retail sales, signal that domestic demand continued
to increase rapidly in this quarter.
Growth in the money supply also remained relatively
brisk, while the income velocity of circulation reached
historically low levels in the first half of 2004. The
twelve-month growth rate in the broadly defined money
supply (M3) increased from 12,3 per cent in December
2003 to 14,9 per cent in February 2004, before declining
to 12,1 per cent in June. Moreover, it was mainly the
growth in the transaction demand for money that was
responsible for the high rates of increase in M3 during
the first half of 2004.
Monetary policy stance
Against this background, the Monetary Policy Committee
took note of the moderate improvement in the outlook
for inflation noted above, and came to the conclusion
that it would be appropriate and prudent to lower the
repo rate by 50 basis points to 7,5 per cent per annum
with effect from Friday 13th of August 2004. The Committee
will continue to monitor the various factors that impact
on inflation and will accordingly make any future decisions
based on the inflation outlook.
Enquiries:
Cathy Powers
Tel: (012) 313 4420
Issued by: South African Reserve Bank
12 August 2004
Source: South African Reserve Bank (http://www.reservebank.co.za)
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