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Statement of the Monetary Policy Committee (MPC) by South African
Reserve Bank Governor, Mr TT Mboweni, 7 June 2007 Introduction CPIX
inflation breached the upper end of the inflation target range in April 2007 for
the first time since August 2003. The year-on-year increase of 6,3 percent was
higher than that expected by the bank and most forecasters. The petrol price had
increased by R0,69 per litre in April and this was expected to contribute to an
increase in the inflation rate. This was compounded by strong increases in food
prices as well as generalised increases in some other categories. The breach
of the target is in the past and there is nothing that monetary policy can do
about past inflation. Nevertheless the Monetary Policy Committee (MPC) cannot
ignore the possible impact of this breach on inflation expectations and the public's
understanding of the monetary policy process. Monetary policy acts with a lag
and the focus of the Monetary Policy Committee will remain, as always, on the
medium-term inflation outlook which is the period over which monetary policy can
be effective. Recent developments in inflation 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) increased at a year-on-year
rate of 6,3 percent in April 2007 compared to 4,9 percent in February and 5,5
percent in March. Food and petrol price increases accounted for most of the increase,
but more broad-based pressures are also becoming evident. If food and energy were
excluded, CPIX inflation would have measured 4,6 percent in April compared to
3,9 percent in January. Although this measure is still well within the target
range, the recent strong upward trend is indicative of more broadly-based price
pressures. The biggest impetus to the increase in the inflation rate in
April came from the petrol price. Petrol prices increased at a year-on-year rate
of 15,5 percent in April compared to 7,9 percent in March 2007. Food price inflation
also continued its upward trend measuring 7,8 percent and 8,6 percent in March
and April respectively. The higher food price inflation in April was driven mainly
by grain product and meat price increases. Grain product prices increased at a
year-on-year rate of 10,6 percent compared to meat price increases of 10,8 percent.
The latter, although still high, are significantly lower than the peak increases
of almost 20 percent in October and November last year. Prices of household consumables
increased by eight percent in April, compared to 6,1 percent in February. Services
price inflation has also been increasing steadily, having measured 5,5 per cent
on a year-on-year basis in April, compared to 4,6 percent in January. Certain
components of housing services made a significant contribution to this upward
trend. Pressures on inflation continue to be moderated by price declines in clothing,
footwear, furniture and recreation and entertainment. Production price inflation
increased at a year-on-year rate of 11,1 percent in April, compared to 9,5 percent
and 10,3 percent in February and March respectively. These developments point
to further pressures on CPIX inflation in the coming months. The April increase
was the highest since December 2002. Apart from textiles, clothing and footwear,
the increases were across a wide spectrum. Prices of domestically produced goods
increased by 11,2 percent in April compared to 10,5 percent for imported goods.
The outlook for inflation The most recent central forecast
of the bank's models indicates a further deterioration in the inflation outlook
compared to the previous forecast. The forecast, which takes account of the petrol
price increases of May and June, projects that CPIX inflation will remain marginally
above the upper level of the inflation target range in the second quarter of 2007.
After a technical decline in the third quarter, CPIX inflation is expected to
marginally exceed six percent in the subsequent two quarters, peaking at an average
of 6,3 in the first quarter of 2008. Thereafter, CPIX inflation is projected to
follow a downward trajectory and to average 5,3 percent in the fourth quarter
of 2008. The higher trend of the forecast in the near term compared to the previous
forecast is a result of a slightly higher oil price assumption. The committee
continues to view the risks to the outlook to be strongly on the upside. Inflation
expectations are an important indicator of possible future inflation trends because
of their impact on wage and price setting processes. According to the most recent
inflation expectations survey conducted in May on behalf of the Bank by the Bureau
for Economic Research at the University of Stellenbosch, there had been some deterioration
in inflation expectations which had moved back to the levels of the fourth quarter
of 2006. Nevertheless inflation expectations still remained within the inflation
target range. Respondents expected CPIX inflation to average 5,5 percent this
year and to moderate to 5,3 percent and 5,2 percent respectively in the coming
two years. Expectations of trade unionists increased the most since the previous
survey. Labour and business expectations were then significantly higher than those
of analysts, but all groups were within the target range for all three survey
years. The bond markets have also shown evidence of some deterioration
in expectations. In reaction to the April inflation data, long-term bond yields
increased further and the yield curve shifted upwards, although it remained inverted.
The break-even inflation rate, which is the difference between the yield on conventional
bonds and the yield on inflation-linked bonds, increased by about 50 basis points
to around 5,6 percent since the end of May. The MPC identified a number of upside
risks to the outlook. These include food and oil prices and continued high rates
of household consumption expenditure. The assessment of most of the other variables
was relatively unchanged since the previous meeting. Oil remains an upside
risk to the inflation outlook. The price of North Sea Brent crude oil has averaged
US$68 per barrel since the previous MPC meeting and is currently trading above
US$72 per barrel. International prices remain dominated by geopolitical tensions,
fluctuating inventory levels and supply disruptions in a number of oil-producing
countries. Futures prices suggest that upward pressure on oil prices is expected
to persist in the near future. The domestic petrol price was increased by R0,34
and R0,23 per litre in May and June respectively. These increases, which were
due to international product price increases, were cushioned to some extent by
the behaviour of the exchange rate. Pressure on inflation emanating from
food price increases is expected to persist for some time. This may be attributed
to international food price developments which have seen the diversion of grain
products to biofuel production and increased food demands as a result of higher
global real incomes. Household consumption expenditure has remained strong
although preliminary estimates suggest that there has been a slight moderation
in the first quarter. Growth in new passenger motor vehicle sales has been declining
since late last year, but the most recent trend has been distorted by problems
related to the teething challenges during the introduction of the new electronic
licensing system. Sales of commercial and heavy vehicles remain strong, reflecting
the strong state of the economy. Growth in retail sales declined to a year-on-year
rate of 8,0 percent in February compared to 9,9 percent the previous month, but
growth accelerated to a year-on-year rate of 10,1 percent in March. The
continued underlying strength in household consumption expenditure is reflected
in the high rates of domestic credit extended to the private sector. Twelve-month
growth in banks, loans and advances extended to the private sector measured 26,2
percent in March before increasing to 27,4 percent in April. Adjusted for the
cumulative effect of securitisation transactions, growth has remained around 29
percent. Growth in mortgage advances, which had previously exhibited a slight
declining trend, increased at a year-on-year rate of 27,6 percent in April. In
line with declining trend in passenger motor vehicle sales, instalment sale and
leasing finance increased by 17,2 percent and 16,9 percent in March and April
respectively. Consistent with the growth in fixed capital formation, advances
to the corporate sector accounted for the strongest increases in bank lending.
The sustained strength in consumer demand has been underpinned by higher
levels of employment, higher real incomes and improved household balance sheets.
Higher equity and house prices contributed to this positive wealth effect. The
All-share index on the Johannesburg Securities Exchange (JSE) Limited reached
new heights in the past weeks, in tandem with strong equity market performances
in a number of countries. According to the Absa and Standard Bank house price
indices, house prices continue to increase although at moderately slower rates.
South Africa's economic growth rate declined moderately in the first quarter
of 2007 to an annualised quarter-on-quarter rate of 4,7 percent. The decline is
attributable mainly to a contraction in the mining sector and slower manufacturing
sector growth. The construction sector grew at over 21 percent mainly as a result
of non-residential construction and civil engineering projects. This strong performance
is indicative of the continuing domestic investment boom which has been given
further impetus by the investment activities of public corporations. The
economy is still growing at a rate around estimated potential and the higher rate
of fixed capital formation, which is now in excess of 20 percent of Gross Domestic
Product (GDP), is expected to sustain economic growth going forward as well as
increase the growth potential of the economy. The utilisation of production capacity
in manufacturing increased by a further 0,3 percentage points in the first quarter
of 2007 to 86,5 percent. However, growth in the manufacturing sector appears to
have moderated somewhat. Manufacturing output declined between March and April
of this year and the most recent Investec Purchasing Managers Index (PMI) also
indicates a slowdown of the manufacturing sector's growth momentum. According
to the most recent Wage Settlement Survey by Andrew Levy Employment Publications,
wage settlements averaged 6,5 percent in 2006 and remained at this rate in the
first quarter of 2007. These increases are consistent with the inflation target
if account is taken of positive changes in labour productivity. The exchange
rate of the rand is trading at levels similar to those prevailing at the time
of the previous MPC meeting. The volatility observed since the last meeting can
be attributed mainly to movements of the United States dollar against other currencies.
The deficit on the trade account of the balance of payments narrowed as
a result of an expected decline in the volume of imported oil. Preliminary data
suggest that the deficit on the current account of the balance of payments in
the first quarter was narrower than that experienced in the final quarter of 2006.
As before, this deficit was comfortably financed by net financial inflows. In
the year to date, non-resident net purchases of bonds and equities have totalled
around R45 billion. The bulk of this has been equity investments, reflecting continued
confidence in South Africa's macroeconomic policy framework and the related growth
prospects. This is also illustrated further by the revision of the outlook
from stable to positive of South Africa's external sovereign debt rating by Moody's
rating agency. Further progress was also made with international reserve accumulation.
At the end of May, official gross gold and other foreign exchange reserves had
increased to US$ 27,9 billion, while the international liquidity position had
risen to US$ 25,5 billion. Aside from oil and food price developments,
the international economic environment remains relatively favourable. World growth
is expected to remain strong although slightly lower than that achieved last year.
The main risk to growth is seen to emanate from the housing market in the United
States, although this risk appears to have dissipated somewhat. In general, international
interest rates are not expected to decline in the near future, while further increases
may still occur in some regions. The generally tighter monetary policy stance
is expected to keep inflation contained despite pressures from rising oil and
food prices. Growth prospects in the Common Monetary Area (CMA) region remain
positive, although member countries are also experiencing inflation pressures
from food and oil prices. Monetary policy stance The Monetary
Policy Committee has decided that in view of the further deterioration in the
inflation outlook, the monetary policy stance needs to be adjusted to ensure that
CPIX inflation returns to within the inflation target range over time. Accordingly,
the repo rate will be increased by 50 basis points to 9,5 percent per annum with
effect from Friday, 8 June 2007. The MPC will continue to monitor developments
which have a bearing on inflation outcomes and will not hesitate to adjust the
policy stance as may be appropriate. Contact person: Thandi
Moya
Tel: 012 313 3027
E-mail: Thandi.Moya@resbank.co.za
Issued by: South African Reserve Bank
7 June 2007
Source:
South African Reserve Bank (http://www.reservebank.co.za)
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