South African Reserve Bank

PRESS STATEMENT
EMBARGO DELIVERY
23 July 2015


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 the global
environment has been dominated by heightened uncertainty relating to the debt
crisis in Greece and the sharp decline in equity prices in China. While the tail risks
from these events appear to have dissipated somewhat, uncertainties still remain. At
the same time, the risks associated with financial market volatility related to the
timing of the first increase in the US policy rate persist. Domestically, the growth
outlook remains weak, as both the supply and demand sides remain constrained
amid declining business and consumer confidence. The inflation forecast has
deteriorated slightly since the previous meeting, notwithstanding the lower-thanexpected outcome in June. Headline inflation is expected to breach the upper end of
the target range during the first two quarters of next year, while upside risks posed
by the exchange rate have increased.

The year-on-year inflation rate as measured by the consumer price index (CPI) for all
urban areas measured 4,6 per cent and 4,7 per cent in May and June respectively.

The latter surprised on the downside, due inter alia to lower than expected increases
in food price and rental inflation, with upside pressures coming from higher petrol
prices. The categories of housing and utilities, food and non-alcoholic beverages,
and miscellaneous goods and services contributed 3,1 percentage points to the
overall inflation outcome. The Bank’s measure of core inflation, which excludes food,
fuel and electricity, moderated from 5,7 per cent in May to 5,5 per cent in June.

Producer price inflation for final manufactured goods continued its upward trend
having reached a low point of 2,6 per cent in February. In April and May, the PPI
measured 3,0 per cent and 3,6 per cent respectively. The latter was above market
consensus, and driven by higher than expected food, beverage and tobacco product
prices, which, at 2,2 percentage points, was also the main contributor to the annual
change in the PPI. The upward trend is expected to persist, driven by rising
agricultural crop prices and electricity tariffs.
The inflation forecast of the Bank has changed marginally since the previous
meeting of the MPC, with headline inflation now expected to average 5,0 per cent in
2015, up from 4,9 per cent previously. The forecast for the first two quarters of next
year has also been revised up by 0,1 percentage point to 6,9 per cent and 6,1 per
cent respectively, with a return to within the target range by the third quarter.
However, the forecast average inflation for both 2016 and 2017 is unchanged at 6,1
per cent and 5,7 per cent.
The forecast for core inflation is unchanged, and expected to average 5,6 per cent in
2015, and moderating to 5,4 per cent and 5,2 per cent in the next two years. As
before, much of the persistence of core inflation at these levels is attributed to high

levels of wage growth, currency depreciation and inflation expectations entrenched
at the upper end of the target range.

The headline inflation forecast assumes electricity price increases of 13,0 per cent
from July 2016 and July 2017. Although the current multi-year price determination
allows for an 8 per cent increase from July next year, Eskom is expected to apply for
a claw-back on diesel usage, and this accounts for the additional 5 percentage point
assumption in the model. The main assumptions underlying the model are listed in
the annexure to this statement.

Inflation expectations as reflected in the survey conducted by the Bureau for
Economic Research at Stellenbosch University have shown a near-term
deterioration, but are more or less unchanged over the 2 to 3 year horizon. Average
inflation expectations for 2015 and 2016 increased by 0,2 percentage points, to 5,6
per cent and 6,1 per cent, but declined marginally to 5,8 per cent for 2017. The
deterioration was mainly driven by marked increases of 0,6 and 0,4 percentage
points by analysts for 2015 and 2016, and smaller increases by business people.
The expectations of analysts and trade unionists remain within the target, but close
to the upper end of the target range. The expectations of business people are above
the target range with a deterioration over all three years. Average 5-year inflation
expectations increased from 5,8 per cent to 6,0 per cent.

The median inflation expectations of analysts polled in the Reuters Econometer
survey are almost identical to the Bank’s forecast. The break-even inflation
expectations as reflected in the yield differential between conventional government

bonds and inflation linked bonds are relatively unchanged since the previous
meeting, and remain above the target range for all maturities.

Global economic growth has been revised downwards recently, mainly due to the
weak first quarter outcome in the US. While the recovery in the US still appears to be
on track amid continued improvements in the labour market, growth this year is
expected to be closer to the 2 per cent level, compared with expectations of around
3 per cent earlier in the year. The steady, but slow improvement in the euro area has
continued, following a better-than-expected first quarter outcome. However, the
outlook for the region will be dependent in part on avoiding negative spillovers from
the Greek debt crisis. The near term risks from this crisis appear to have been
averted for now, but the longer term sustainability of the Greek debt burden remains
a concern. Growth in Japan is expected to remain positive but subdued.

The Chinese economy grew at a year-on-year rate of 7,0 per cent in the second
quarter, but some moderation is expected in the coming quarters. The sharp
correction in the Chinese equity markets appears to have been contained by strong
intervention by the authorities, and the impact on the broader economy is expected
to be relatively limited, but it does point to some fragility in the financial sector. The
slowdown in China has continued to impact on commodity prices, with the platinum
price, for example, declining to its lowest level in six years. The prospects for a
number of other larger emerging market economies, particularly Russia and Brazil,
remain weak.

Global inflation pressures, particularly in the advanced economies remain benign,
reinforced by declining commodity prices, including oil. Against this backdrop, the
monetary policy stances in most advanced and emerging market economies have
either remained unchanged or become more accommodative since the previous
MPC meeting, with the exception of Brazil where interest rates were increased
further. Monetary policies in the advanced economies are likely to remain
asynchronous: highly accommodative stances in the Eurozone and Japan are likely
to persist for some time, while a start of monetary policy tightening is likely in the US
sometime this year, followed by the UK.

The rand exchange rate has been relatively volatile and depreciated significantly
since the previous meeting of the MPC. The rand, along with a number of other
emerging market currencies, has been particularly sensitive to changing global risk
perceptions relating to the Greek crisis, the volatility in the Chinese equity markets,
declining commodity prices and expectations of the start of US monetary policy
tightening. Since the previous meeting of the MPC, the rand traded in a wide band of
between R11,82 and R12,58 against the US dollar. Over the period, the rand has
depreciated by 5,0 per cent against the US dollar, by 3,6 per cent against the euro
and by 3,5 per cent on a trade-weighted basis.

The rand found some support from the improved current account outcome of 4,8 per
cent of GDP in the first quarter of 2015, and the more favourable recent trade data.
Whilst these better outcomes may reflect the depreciated real effective exchange
rate, further gains are likely to be constrained by the recent decline in commodity

prices. The Bank forecasts a current account deficit of around 4,6 per cent of GDP
for the year.

Global capital flows have remained relatively volatile against the backdrop of
changing risk perceptions. This has been reflected in non-resident bond and equity
flows: according to JSE data, non-residents were net sellers of South African
government bonds to the value of R12,7 billion in May and June, but were net buyers
of equities to the value of R17,7 billion. To date in July, non-residents have been net
buyers of equities and bonds to the value of R3,7 billion and R2,4 billion respectively.

The rand remains a significant risk factor to the inflation outlook given the
vulnerability of the rand and long bond yields to possible US interest rate increases,
as well as a deterioration in South Africa’s terms of trade. The inflation forecast
assumes a relatively stable real effective exchange rate over the forecast period,
implying a nominal effective depreciation in line with inflation differentials between
South Africa and her major trading partners. A nominal depreciation in excess of this
would pose an upside risk to inflation, although this risk could be ameliorated to
some extent should the relatively low pass-through from the exchange rate to
inflation persist. The extent to which US policy tightening is already priced into the
exchange rate also remains uncertain.

The domestic growth outlook remains subdued, amid continued electricity supply
constraints, and weak business and consumer confidence. Growth in the first quarter
of 2015 measured 1,3 per cent, and high frequency data suggest that the second
quarter growth is likely to be broadly similar. The Bank’s forecast for growth in each

year of the forecast period has been revised down marginally, to 2,0 per cent in 2015
and 2,1 per cent in 2016, and rising to 2,6 per cent in 2017 when some easing of the
electricity supply constraint is assumed. However, the risks to growth are still
assessed to be moderately on the downside. The recent further decline in the Bank’s
composite leading business cycle indicator also suggests a continuation of the weak
growth outlook.

The RMB/BER business confidence index has declined for two consecutive quarters,
measuring 43 index points in the second quarter of 2015, with confidence in the
manufacturing sector particularly low, at 29 index points. The physical volume of
manufacturing production has contracted on a month-on-month basis in three of the
first five months of this year, and this sector is expected to record negative growth in
the second quarter. Although the PMI improved in May and June, it remains around
the 50 index point level, consistent with a constrained outlook. The mining sector, by
contrast, has displayed some resilience, particularly in the PGM sub-sector, although
the weaker platinum and palladium prices are expected to create further headwinds.

Underlying this subdued growth outlook is the persistent weakness in growth in
gross fixed capital formation, particularly by the private sector. These trends
contributed to a contraction in non-agricultural formal sector employment on both a
quarter-on-quarter basis, and a year-on-year basis. During the four quarters to the
first quarter of 2015, over 41 000 jobs were shed, of which just over 30 000 were in
the private sector.
Although consumption expenditure of households improved somewhat in the first
quarter of 2015, this was probably induced by temporary factors including the decline

in the petrol price and lower food price inflation. However, following the increase in
personal income taxes alongside higher electricity tariffs and a reversal of the petrol
price declines, the outlook for consumption expenditure has deteriorated. This
negative outlook is reflected in slowing retail sales growth, declining motor vehicle
sales and the continued weak pace in credit extended to households by the banking
sector. Tighter affordability criteria as well as proposals to cap interest charges on
unsecured loans are likely to constrain bank credit extension to households further.
This is in contrast to the continued buoyant growth in credit extension to the
corporate sector. Against this backdrop, the FNB/BER consumer confidence index
reached a 14-year low in the second quarter of 2015.
Notwithstanding the recent moderation in nominal wage growth, the pace of growth
remains high and contributes to the persistence of inflation at higher levels. Year-onyear growth in nominal salaries and wages per worker moderated to 6,7 per cent in
the first quarter of 2015, from 7,3 per cent in the previous quarter. Adjusting for
productivity increases, due in part to employment reductions, labour cost increases
declined to 4,1 per cent in the first quarter. According to Andrew Levy Employment
Publications, the average settlement rate in collective bargaining agreements
declined to 7,8 per cent in the first half of 2015, compared with 8,1 per cent in 2014
as a whole.

Food prices remain a concern to the MPC, despite the continued moderation of food
price inflation at the CPI level having measured 4,6 per cent in May and 4,3 per cent
in June. However, the continuing drought in parts of the country has contributed to
the upside risk to the outlook, despite benign global food price inflation. Maize and
wheat prices have increased significantly since the beginning of the year, and we are

yet to see the full impact on consumer prices. At the PPI level, however, cereal and
crop price inflation accelerated to 17,8 per cent in May, and both wheat and maize
prices are now trading at around import parity levels.

International oil prices have been somewhat weaker since the previous meeting of
the MPC, following higher output by Saudi Arabia, and the prospects of a resumption
of oil exports by Iran. This follows two consecutive months of oil prices in the range
of US$60-65 per barrel. Since early July, spot prices have traded below US$60 per
barrel, while futures prices are currently trading at around US$58 per barrel for
December delivery. The Bank’s forecast assumes a moderate increase in oil prices
over the forecast period. Domestic petrol prices have increased by about 90 cents
per liter in the past two months, but should current trends persist, a price reduction of
around 40 cents per litre is likely in August.
While the June inflation outcomes were below expectations, this respite is expected
to be temporary. The persistence of forecast inflation at elevated levels and the
continued upside risks to the outlook remain a concern to the MPC. Although
inflation is currently within the target range, given the lags in monetary policy
changes on inflation, the focus of policy continues to be on the medium term trend,
and to ensure that inflation remains comfortably and sustainably within the target
range.
Inflation is expected to breach the upper end of the target range for two quarters,
and the medium term trajectory remains uncomfortably close to the upper end of the
target range. The upside risks make this trajectory vulnerable to any significant
changes in inflation pressures.

Although the risks of higher electricity tariffs did not materialise as yet, other upside
risks persist. The rand remains vulnerable to global market reaction to US monetary
policy normalisation, particularly in the context of South Africa’s twin deficits. The
pressures on the exchange rate have been exacerbated by the recent significant
decline in commodity prices, which are likely to impede the favourable current
account adjustment. Some of the rand adjustment has already occurred since the
previous meeting, but further reaction to US monetary policy tightening could cause
inflation to diverge even further from target, and set in motion an exchange rateinflation spiral. Further upside risks are expected to come from food prices, which
have yet to react to significant increases in spot prices of agricultural commodities.
The MPC has indicated for some time that it is in a hiking cycle in response to rising
inflation risks, and a normalisation of the policy rate over time. The MPC is cognisant
of the fact that domestic inflation is not driven by demand factors, and the outlook for
household consumption expenditure remains subdued. Economic growth remains
subdued, constrained by electricity supply disruptions and low business and
consumer confidence and the risks to the outlook remain on the downside. However,
as emphasised previously, we have to be mindful of the risk of second-round effects
on inflation, and the committee is concerned that failure to act against these
heightened pressures and risks will cause inflation expectations to become
entrenched at higher levels.
The MPC has therefore decided to continue on its path of gradual policy
normalisation. Accordingly, the repurchase rate will increase by 25 basis points to
6,0 per cent per annum with effect from Friday 24 July 2015. Four members

favoured a 25 basis point increase, while two members favoured an unchanged
stance.
The expected inflation trajectory implies that the real repurchase rate remains low
and possibly still slightly negative at times, and below its longer term average. The
monetary policy stance therefore remains supportive of the domestic economy. The
continuing challenge is for monetary policy to achieve a fine balance between
achieving our core mandate of price stability and not undermining short term growth
unduly. Monetary policy actions will continue to be sensitive, to the extent possible,
to the fragile state of the economy. As before, any future moves will therefore be
highly data dependent.


Lesetja Kganyago

GOVERNOR

Contact person:
Candice Jeffreys
+27 12 313 4209