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Statement of the Monetary Policy Committee, 12 October 2006 Introduction Recent
domestic economic developments indicate that the risks to the inflation outlook
to which the Monetary Policy Committee (MPC) drew attention in previous statements
remain. The domestic economy continues to grow at a brisk pace while domestic
demand growth has sustained its vibrancy, buoyed by strong credit extension. The
deficit on the current account of the balance of payments continues to be at levels
which may strongly influence the exchange rate outlook. The exchange rate has
depreciated further since the last MPC meeting and broad-based pressure from producer
prices has become more pronounced. Internationally, oil prices have moderated
somewhat, which has allowed for a reduction in petrol prices in two consecutive
months. However, in line with declining oil prices, commodity prices in general
have also declined recently. The outlook for the international economy
remains positive although there are still uncertainties relating to the growth
outlook in the United States of America. The latest World Economic Outlook of
the International Monetary Fund (IMF) says that global growth is expected to moderate
slightly from 5,1 percent in 2006 to 4,9 percent in 2007. Against the background
of generally tighter monetary policies globally, world inflation is expected to
remain under control and average 3,7 percent next year, slightly higher than the
April projection of the IMF. Recent developments
in inflation Inflation has continued to display an upward trend. 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 increased in each
month since April of this year when it measured 3,7 percent. By August this year,
CPIX inflation had increased to 5,0 percent. Goods prices increased at a year-on-year
rate of 6,0 percent compared to 3,5 percent for services in August. The main inflation
drivers in the goods category were again food and petrol prices. The prices of
a number of food products have been increasing at high rates, in particular meat
prices which increased at year-on-year rates of 15,2 percent in August. Meat has
a weight of about 7 percent in the CPIX basket, and in August its contribution
to CPIX inflation was similar to that of petrol and diesel. Petrol and diesel
prices, which have a weight of 5,04 percent in the CPIX basket, increased at year-on-year
rates of 22,1 percent. By contrast, clothing, footwear and furniture and equipment
prices continued to decline, while administered prices excluding energy increased
at a year-on-year rate of 4,2 percent. Production price inflation increased
markedly and across a broad spectrum of categories. Measured year-on-year, production
price inflation had increased to 9,2 percent in August 2006. Of particular concern
was the 9,6 percent increase in domestically produced goods inflation, up from
8,1 percent the previous month. Imported goods inflation measured 7,8 percent
in August compared with 8,2 percent in July. The categories displaying the highest
month-on-month increases were agricultural products, manufactured food and electricity,
gas and water. The outlook for inflation In the short term,
the increase in CPIX inflation is expected to be moderated somewhat by the reductions
in the domestic petrol price, amounting to R0,36 and R0,50, which took effect
in September and October respectively. Pressures emanating from production prices,
however, indicate that some countervailing movements can be expected. The outcome
of the South African Reserve Bank's (SARB) forecasting models shows that over
the forecast period, inflation is expected to continue its upward trend towards
the upper end of the target range and remain at levels of around seven percent
between the second and fourth quarters of 2007. Thereafter CPIX inflation is expected
to decline gradually to reach around 5,4 percent by the end of the forecast period
in the fourth quarter of 2008. Market expectations of inflation, as indicated
by the break-even inflation rates (i.e. the yield differential between inflation-linked
bonds and conventional government bonds); also show an upward trend over the shorter
maturity range. Inflation expectations as reflected in the survey conducted on
behalf of the SARB by the Bureau for Economic Research (BER) have also moved higher.
Compared to the previous quarter, inflation expectations during the third quarter
of this year increased in respect of every forecast year. Average inflation expectations
increased by 0,5 percent for 2006 to 4,9 percent, while for 2007 they increased
by 0,4 percent to 5,3 percent. Inflation is then expected to decline to 5,0 percent
in 2008. Despite this upward movement, expectations are still within the inflation
target range during all the forecast years. Given the importance of inflation
expectations in the price and wage formation process, it is vital that the MPC
remains vigilant to ensure that expectations stay entrenched within the three
to six percent range. A number of factors have contributed to the adverse
inflation outcomes and outlook, and continue to pose a risk to future outcomes.
Domestic expenditure remained buoyant in the second quarter of this year. Real
domestic final demand increased at an annualised rate of 10 percent in the second
quarter, with strong growth in final consumption expenditure by households and
general government, as well as fixed capital formation. Strong household
consumption expenditure remains one of the primary risk factors. In the second
quarter of this year, household consumption expenditure increased at an annualised
rate of 8 percent, the highest quarter-on-quarter growth rate since 1995. There
are few indications that this trend has been reversed despite the most recent
interest rate changes. However it is recognised that it is possibly too early
to assess fully the impact of monetary policy actions. One tentative indication
of a possible slowdown in demand growth is seen in motor vehicles sales. In the
third quarter of this year, sales of new motor vehicles declined by 0,3 percent.
On a month-on-month basis, sales in September declined by 3,6 percent. This
strong demand is supported by higher asset prices and increased credit extension
to the private sector. Share prices on the Johannesburg Stork Exchange (JSE) securities
exchange reached new record highs recently while house prices have continued to
increase, albeit at a slower rate. Growth over twelve months in total loans and
advances extended to the private sector grew at a level of 26,1 percent in August.
Mortgage advances continued to be the largest component of credit extension. This
component is likely to react to interest rate changes with a lag, given the time
taken to finalise property transfers. The higher rates of credit extension have
contributed to the further increase in household indebtedness which in the second
quarter of this year rose to 70 percent of household disposable income. Growth
in money supply (M3) remains brisk. Twelve-month growth in money supply decelerated
from 23,0 percent in June to 21,2 percent in July before accelerating marginally
to 21,4 percent in August. The income velocity of circulation of M3 declined from
1,43 in the first quarter of 2006 to a low of 1,37 in the second quarter. This
is yet another indication of ample liquidity in the South African economy. Recent
exchange rate developments might pose a risk to the inflation outlook. Since early
May, the rand has depreciated on a trade-weighted basis by almost 22 percent.
At these levels, it is possible that some pass-through to higher prices might
occur. The challenge for monetary policy is to ensure that this effect is minimised.
A part of the explanation for the recent adjustment in the rand exchange
rate lies in the reaction of the market to the current account deficit, which
has averaged over six percent of Gross Domestic Product (GDP) during the first
half of this year. Other factors influencing the exchange rate include the lower
commodity prices, the re-pricing of risk in a number of emerging markets and a
general tightening of monetary policy globally. Whilst noting potential
risks that may emanate from the relatively high deficit on the current account
of the balance of payments, the MPC noted that this deficit continues to be reasonably
well financed. The overall balance of payments situation is in surplus and has
allowed further improvements in the external position of the country, with official
reserves continuing to improve. Official gross gold and other foreign exchange
reserves stood at US$24,6 billion at the end of September 2006 and net reserves
amounted to US$21,2 billion. Food prices also pose a significant risk to
inflation. Food prices in general have increased by 7,2 percent and agricultural
prices at the producer price level have increased at a year-on-year rate of 20,4
percent. In 2005 food price inflation averaged 2,1 percent and exerted significant
downward pressure on the overall inflation trend. Higher maize prices are also
likely to be sensitive to exchange rate developments. Maize product inflation
in CPIX is on an upward trend but is still relatively low, having measured 4,7
percent in August, and further pressure is expected from this source. There
have, however, been some positive developments. In particular, the threat to inflation
posed by the international oil prices has subsided to some extent. Having reached
levels of almost US$80 per barrel in August of 2006, the price of Brent crude
has now fallen to below US$60 per barrel. The timing of this adjustment has happened
by chance or luck, as a high and rising oil price coupled with a depreciating
rand would have had a marked and rapid impact on inflation. In August and September,
the decline in international oil prices more than offset the upward pressure exerted
by the exchange rate on petrol prices. Despite this positive development, the
MPC considers the risk to inflation from this source still to be on the upside.
The tight supply and demand conditions in the oil markets coupled with the sensitivity
of oil prices to geopolitical tensions mean that oil prices could respond quickly
to any new adverse developments. Furthermore, the decision by Organisation of
the Petroleum Exporting Countries (OPEC) to cut quotas by 1 million barrels per
day could slow the decline in oil prices. Labour market developments do
not appear to pose a threat to the inflation outlook at present. Having increased
by 7,3 percent in the first quarter of this year, unit labour costs increased
by 3,2 percent in the second quarter. Trends in inflation expectations will be
critical in the months ahead. Should expectations increase significantly above
those indicated earlier, this is likely to be reflected in higher wage demands
which may impact on the price formation process. Although at this stage wage costs
do not pose a threat to inflation, these developments will be closely monitored
by the MPC. The developments outlined above have taken place against the
background of a buoyant economy. In the second quarter of this year, the economy
grew by 4,9 percent on an annualised basis, compared to four percent in the previous
quarter. Nevertheless economic growth this year is still expected to be lower
than the 4,9 percent average recorded last year. At these levels, growth is still
in line with, or slightly above, what our studies indicate to be the potential
output of the economy. The Rand Merchant Bank/BER Business Confidence Indicator
is still at a high level, while the Investec/BER Purchasing Manager's Index (PMI),
although lower in October, still reflects a positive outlook for the manufacturing
sector. The recent BER manufacturing survey indicates that although there has
been a marginal decline in confidence in the consumer goods sector, the capital
and intermediate goods sectors have maintained a positive outlook. Monetary
policy stance Having considered in detail all the recent economic data
and other developments impacting on inflation, the MPC remains concerned about
the outlook for inflation and is of the view that the risks to the outlook are
still on the upside. Accordingly the MPC has decided that a further upward adjustment
in the repo rate is appropriate at this juncture. The repo rate is therefore increased
by 50 basis points to 8,5 percent per annum with effect from Friday, 13 October
2006. The Monetary Policy Committee will continue to monitor all economic, financial
and other relevant developments and stands ready to act in order to ensure that
the monetary policy stance remains consistent with achieving the inflation target.
Enquiries: Samantha Henkeman
Tel: (012) 313 4669
E-mail:
Samantha.Henkeman@resbank.co.za
Issued by: South African Reserve Bank
12 October 2006 Source:
South African Reserve Bank (http://www.resbank.co.za)
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