MPC Statement July 19th, 2018


South African Reserve Bank

PRESS STATEMENT
EMBARGO DELIVERY
19 July 2018


STATEMENT OF THE MONETARY POLICY COMMITTEE

Issued by Lesetja Kganyago, Governor of the South African Reserve Bank
Since the previous meeting of the Monetary Policy Committee (MPC), several risks
to the inflation outlook have begun to materialise. While headline inflation is
comfortably within the inflation target band, indications are that we have passed the
low point of the current cycle. Developments in the international environment have
placed upward pressure on the inflation trajectory, while the domestic growth outlook
remains challenging.
The year-on-year inflation rate, as measured by the consumer price index (CPI) for
all urban areas, was 4.4% in May 2018 and accelerated to 4.6% in June. Goods
price inflation increased to 4.2% (up from 3.5% in May), while services price inflation
moderated to 4.9% (down from 5.3%). The South African Reserve Bank’s (SARB)
measure of core inflation – which excludes food, fuel and electricity – declined to
4.2% in June. Producer price inflation for final manufactured goods increased
marginally to 4.6% in May.
MPC Statement July 19th, 2018


Despite remaining within the target band throughout the forecast period, the SARB’s
model projects an increase in headline inflation, peaking at levels closer to the upper
end of the target range. Thus far, the impact of the value-added tax (VAT) increase
appears to have been less than anticipated. However, the weaker rand exchange
rate and the higher oil price assumptions result in a more elevated inflation trajectory.
Headline inflation is now expected to average 4.8% in 2018 (down from 4.9%) before
increasing to 5.6% in 2019 and decreasing again to 5.4% in 2020 (up from 5.2% in
both years). Headline CPI inflation is expected to peak at around 5.7% in the first
and second quarters of 2019 before declining to 5.3% at the end of 2020. The
forecast for core inflation is 4.6% in 2018 (up from 4.5%), 5.5% in 2019 and 5.3% in
2020 (up from 5.1% in both years).
Inflation expectations, as reflected in the survey conducted by the Bureau for
Economic Research (BER) during the second quarter of 2018, are largely
unchanged in the near term, averaging 5.2% in 2018, 5.4% in 2019 and 5.5% in
2020. Five-year-ahead inflation expectations are at a historical low of 5.4%.
Expectations implicit in the break-even inflation rates (i.e. the yield differential
between conventional and inflation-linked government bonds) declined marginally
across all maturities.
While the global economic outlook has remained broadly favourable, expectations
are that world growth will begin to slow in the third quarter of 2018. In addition,
escalating trade tensions are contributing to uncertainty around global trade. World
trade volumes contracted sharply in April 2018 – the worst performance since May
2015. The global inflation outlook remains benign but is on a moderate upward path,
MPC Statement July 19th, 2018


largely due to the rising oil prices. The prices of most other commodities have been
retreating.
Since the previous meeting of the MPC, the rand has depreciated by 7.2% against
the US dollar, by 6.2% against the euro, and by 4.9% on a trade-weighted basis. At
current levels, the SARB’s model assesses the rand to be undervalued. It is likely
that the local currency, along with other emerging market currencies, will remain
volatile. The implied starting point for the rand is R13.40 against the US dollar
compared with R12.37 at the time of the previous MPC meeting.
A key external risk to the rand remains the possibility of tighter global financial
conditions. However, the pace of monetary policy normalisation in the advanced
economies continues to be gradual. At this stage, further policy tightening by the
United States (US) Federal Reserve (Fed) is expected to follow a measured path in
the absence of significant inflation or growth surprises. Higher-than-expected US
fiscal deficits could result in a stronger monetary policy response.
The domestic economic growth outlook for this year is weaker than we had expected
in May. Following the broad-based contraction of 2.2% in the first quarter and early
indications of modest growth in the second quarter, the SARB’s forecast now
indicates a growth rate of 1.2% for 2018 compared with 1.7% previously. The
forecast for 2019 is 1.9%, marginally higher than the previous forecast of 1.7%, while
the forecast for 2020 is unchanged at 2.0%. At these growth rates, the negative
output gap is wider in the near term but is still expected to close in 2020.
The composite leading business cycle indicator declined for the second consecutive
month in April, consistent with a deteriorating outlook. Business confidence, as
reflected in the Rand Merchant Bank (RMB)/BER business confidence index,
MPC Statement July 19th, 2018


decreased to 39 index points in the second quarter. In this context, gross fixed
capital formation contracted by 3.2% in the first quarter and is expected to remain
weak in 2018.
Consumption expenditure by households, although slightly weaker than last year, is
expected to be positively impacted by the improved consumer confidence and the
increase in households’ disposable income. In the near term, however, consumption
expenditure is likely to be constrained by the VAT increase and other tax changes,
weak employment growth as well as subdued growth in credit extension to
households. Although credit extension to households increased earlier in 2018,
year-on-year growth remains low.
Average wage growth is expected to remain elevated at around 7% over the forecast
period. This is particularly a concern if labour productivity growth continues to
decline. Much of the upward pressure on wage inflation arises from the public sector
wage settlement, which is at levels above headline inflation.
Higher international oil prices will contribute to petrol price inflation in 2018. The
impact on headline inflation is somewhat moderated by lower food price inflation.
Annual food price inflation is expected to remain within the target range over the
forecast period, and is not seen as a major risk to the inflation outlook. This is largely
driven by an adequate supply of grains over the near term, alongside moderating
meat price increases.
The MPC noted the rising inflation trajectory which, while remaining within the target
range, is moving closer to the upper end of the range.
MPC Statement July 19th, 2018


Key uncertainties in the global environment remain. The continued strength of the
US dollar (which has appreciated against most currencies), any sustained elevation
of oil prices, escalating trade tensions as well as geopolitical developments continue
to pose risks to the inflation outlook. The rand will remain sensitive to changes in
global monetary policy settings and investor sentiment towards the emerging
markets.
The MPC assesses the risks to the inflation forecast to be on the upside. A number
of key risks and uncertainties highlighted in recent meetings persist. Electricity prices
continue to pose a further upside risk.
The growth forecast has deteriorated, and the outlook remains constrained. Demand
pressures in the economy are not assessed to pose a risk to the inflation outlook.
The MPC assesses the risks to the growth forecast to be more or less balanced. A
firm commitment to credible structural policy initiatives and implementation is
required to make a marked impact on employment and potential output.
The MPC unanimously decided to keep the repurchase rate unchanged at 6.5% per
annum. At these levels, the MPC still assesses the stance of monetary policy to be
accommodative and appropriate given the current state of the economy. However,
the MPC has noted the deteriorating inflation outlook, driven mainly by supply-side
factors. The approach of the MPC continues to be one of looking through the firstround effects and focusing on the second-round effects. With risks and uncertainties
at higher levels, the MPC will continue to be vigilant and will not hesitate to act
should there be second-round effects that take us significantly away from the
midpoint of the inflation target range.
MPC Statement July 19th, 2018


The implied path of policy rates generated by the Quarterly Projection Model has
changed since the previous MPC meeting. Whereas previously four increases of
25 basis points each by the end of 2020 were indicated, five increases of 25 basis
points are now implied. As emphasised previously, the implied path remains a broad
policy guide which can and does change in either direction between meetings in
response to new developments and changing risks. The MPC does not mechanically
respond to changes in the path, and the assessment of the balance of risks to the
forecast cannot be done by the model.

Lesetja Kganyago
GOVERNOR
The next statement of the Monetary Policy Committee will be released on
20 September 2018.

Contact person:
ZamaNdlovu Ndlovu
012 399 7118