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Statement of the Monetary Policy Committee, by Mr TT Mboweni,
Governor of the South African Reserve Bank, 14 April 2005 Introduction Over
the past two months, the global environment has continued to be characterised
by uncertainty. International oil prices have reached record highs despite increases
in output quotas by OPEC and have confounded expectations of a short-lived spike.
Higher oil prices have resulted in a downward revision of global growth estimates.
The imbalances in the US remain, and the outlook for the dollar remains uncertain.
Against the dollar, the rand has generally traded in a range higher than that
in 2004. Domestically, expenditure remains strong and the robust economic
growth has been accompanied by six consecutive quarters of employment growth in
the formal non-agricultural sectors of the economy. However, there has recently
emerged evidence of some slackening of activity in the manufacturing sector. Despite
the uncertain global environment, the inflation outlook remains favourable. Recent
developments in inflation Inflation as measured by the consumer price
index for metropolitan and other urban areas excluding the interest cost on mortgage
bonds (CPIX) has remained within the inflation target range of 3-6 per cent for
the past 18 months. After declining to 3,6 per cent in January of this year, it
declined further to 3,1 per cent in February. This is the lowest rate of increase
of CPIX since the inception of this measure of inflation. The recent downward
movement was due in part to consecutive decreases in the petrol price totalling
65 cents per litre between December 2004 and February 2005. Increases in
most of the other components of the CPIX were also well contained, while footwear
and clothing prices continued to decline. Food prices also continued to increase
at a subdued year-on-year rate of 1,6 per cent in February while total goods price
inflation measured 1,8 per cent. Of particular significance is the fact that services
inflation has continued its gradual downward trend. In January year-on-year services
inflation declined below the upper end of the inflation target range to 5,9 per
cent, and declined further to 5,6 per cent in February. This was the first time
since the introduction of inflation targeting that services inflation has been
at these levels. This partly reflects progress made by the public authorities
in curbing administered price increases. The overall administered price index
however remains above the target range because of the impact of the petrol price,
which has a significant weighting in this index. Production price inflation
has also remained low, to an important degree due to the impact of the exchange
rate of the rand. In January and February, the respective year-on-year inflation
rates for the overall PPI were 1,4 per cent and 1,2 per cent. Prices of imported
goods increased year-on-year by 0,3 per cent in January, and declined by 0,7 per
cent in February. However, the prices of domestically produced goods also remained
well contained. In the first two months of this year, the year-on-year inflation
in these prices declined to 1,9 per cent and 1,8 per cent respectively, as the
prices of agricultural products, manufactured foodstuff and textiles declined. The
outlook for inflation Despite the uncertainties created by the oil market
developments, the outlook for inflation remains favourable. The continued low
level of production price inflation indicates that significant generalised upward
pressure on consumer prices is not expected in the short term. However the recent
increases in the petrol price of 42 cents per litre in March and 40 cents per
litre in April and possible further increases expected next month suggest that
CPIX inflation may have reached its low turning point in February. According to
our central forecast, CPIX inflation will begin to rise moderately over the coming
months to peak at a level of around 5,25 per cent early next year before resuming
a downward trajectory towards the mid-point of the inflation target range. This
favourable forecast is underpinned by a number of factors. The latest inflation
expectations survey conducted on behalf of the Bank by the Bureau for Economic
Research (BER) at the University of Stellenbosch shows a significant decline in
inflation expectations. According to the survey, CPIX inflation expectations reached
their lowest level since the BER started the survey in 2000. For the first time,
all groups of respondents expect inflation to be below the upper end of the inflation
target band. On average CPIX inflation is expected to be at 4,5 per cent, the
mid-point of the band for 2005, down from 5,5 per cent in the previous survey.
CPIX inflation is also expected to remain within the target range for the next
3 years. This outcome indicates that there is an increasing acceptance by the
South African population that the low levels of inflation achieved over the past
18 months can be sustained. These improved expectations are corroborated by the
gap between the nominal yield on conventional bonds and the real yield on inflation-linked
bonds. Although the expected long-term inflation implied by these yields has risen
since their February lows, they nevertheless indicate longer-term expectations
comfortably within the target range. Government's fiscal policies also remain
supportive of monetary policy. Higher than expected tax revenues have resulted
in a deficit before borrowing significantly lower than the original estimate of
3,1 per cent and the revised estimate of 2,3 per cent of GDP announced in the
budget. Other positive factors include continued low world inflation, progress
being made with respect to administered prices and low levels of food price increases
in part as a result of the bumper maize crop. Not all the positive factors
identified in the previous statement of the MPC have improved however. Unit labour
cost developments present a mixed picture. In the last MPC statement we commented
on the marked moderation in salary and wage increases. Revisions to the Survey
of Employment and Earnings undertaken by Statistics South Africa now indicate
that average earnings rose by 7,2 per cent and 10,5 per cent in the third and
fourth quarters respectively. With labour productivity growth declining to 0,6
per cent and 0,4 per cent in those quarters, it implies an increase in unit labour
cost in the formal non-agricultural sectors of the economy of 6,6 per cent in
the third quarter, compared to the original estimate of 4,9 per cent, and 10,1
per cent in the fourth quarter. The average unit labour cost increase for 2004
was 7,3 per cent compared to 4,0 per cent in the previous year. While these figures
taken at face value should be a cause for concern, they do not necessarily reflect
a reversal of the downward trend in reported nominal wage settlements, which according
to recent surveys averaged below 7 per cent in 2004 and around 6 per cent in the
first quarter of 2005. These figures appear to confirm the lagged nature of wage
settlements, and the continuing adjustment to lower inflation rates. Because of
their importance to the inflation process, these developments will be closely
monitored by the MPC. There are a number of upside risks to the inflation
outlook which the MPC has taken cognisance of. The most important risk factor
remains the uncertainty relating to the international oil prices. The price of
Brent crude has averaged around US$54 per barrel since the beginning of April,
compared to US$45 per barrel in February and the outlook for oil prices has become
increasingly uncertain. Domestic expenditure continues to be robust. Growth
in real gross domestic expenditure averaged 6,5 per cent in 2004, and real final
demand averaged 6,8 per cent. This was a result of acceleration in real household
and government consumption expenditure and real gross fixed capital formation.
The strong growth in private sector consumption continues to be sustained by relatively
low nominal interest rates, higher asset prices, higher levels of consumer confidence
and increased real disposable incomes. The higher levels of expenditure
continue to be reflected in the money supply aggregates and credit extension by
the banking sector. Although the year-on-year monthly rates of increase in M3
have remained fairly stable at around the 12 per cent level, the quarter-to-quarter
annualised rate of increase in the fourth quarter of 2004 amounted to 17,6 per
cent. In January and February of 2005 the month-on-month annualised growth rate
of loans and advances of banks to the private sector was 22,5 per cent and 20,6
per cent respectively. This was mainly the result of asset-backed credit growth
which recorded similar rates of increase. However, the rate of increase in house
prices has been moderating for the past year. Real gross domestic product
growth averaged 3,7 per cent in 2004 compared to 2,8 per cent in 2003. As expected,
the quarter-on-quarter annualised growth rate of 4,0 per cent in the fourth quarter
of 2004 was slower than the previous quarter rate of 5,7 per cent. Moreover, there
is evidence of a slackening of activity in the manufacturing sector. The outlook
for growth and for exports in particular will depend to a significant degree on
growth developments internationally. Although output growth has been robust,
the higher expenditure growth has continued to put pressure on the current account
of the balance of payments. The current account deficit widened in the fourth
quarter of 2004 to 4,0 per cent of GDP, up from 3,1 per cent in the third quarter.
It measured 3,2 per cent of GDP for the year as a whole. However as has been the
case for the past three years, these deficits continue to be comfortably financed
by inflows on the financial account of the balance of payments. This enabled us
to continue building up our levels of foreign exchange reserves at a moderate
pace- gross foreign exchange reserves rose to US$15,9 billion and the international
liquidity position to US$12,4 billion at the end of March. The prospects
for the international economy have become more uncertain and the IMF and the World
Bank have both revised down their forecast for growth in 2005, particularly in
the Eurozone and Japan. The IMF has also warned of an increasingly unbalanced
global expansion and the risks posed by higher oil prices, rising inflationary
pressures, and the large and growing indebtedness of the United States to the
rest of the world. Given the continued imbalances in the US economy, the outlook
for the US dollar remains uncertain. The rand exchange rate will continue
to be affected by these developments. The rand strengthened after the last MPC
meeting, but has weakened more recently as a result of the stronger dollar and
the generalised weakness in emerging market assets. It is nevertheless slightly
stronger than it was at the time of the last meeting and has traded over the past
six months at a range higher than for the main part of 2004. Monetary
policy stance The MPC has carefully reviewed the above-mentioned developments
and future prospects for inflation and the economy, taking particular account
of the areas of uncertainty identified and the associated risks. The MPC
welcomed the evidence of a further material decline in inflation expectations
and noted that on balance the outlook for inflation, on the basis of our central
forecast, was that CPIX inflation would remain comfortably within the target range
of 3-6 per cent over the next two years, even taking account of the impact of
the recent rise in oil prices. Although the overall performance of the South African
economy seems to be reasonably well sustained, the MPC noted with concern evidence
of some slackening in activity in some sectors of the economy as a result of the
move by the rand to a higher trading range over the past six months. It remains
the view of the MPC that a competitive and stable exchange rate would contribute
to continuing sustainable growth in output and employment. Taking all of the above-mentioned
developments into consideration, the MPC has decided to reduce the repo rate by
50 basis points to 7,0 per cent per annum with immediate effect. The MPC is convinced
that this is appropriate in the circumstances, and consistent with maintaining
inflation within the target range. The MPC will continue to monitor domestic
and international developments closely, and will not hesitate to adjust rates
as and when necessary to ensure that inflation remains within the target range
mandated by the government of 3-6 per cent. Contact person: Cathy Powers
Tel: (012) 313 4420
E-mail: Cathy.Powers@resbank.co.za Issued
by: South African Reserve Bank (SARB)
14 April 2005
Source: South
African Reserve Bank (http://www.reservebank.co.za)
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