Monetary Policy
Review


May 2008
Monetary Policy
Review
May 2008
South African Reserve Bank
Monetary Policy Review May 2008
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ISSN: 1609-3194
South African Reserve Bank
Monetary Policy Review May 2008
Contents
Monetary Policy Review


Statements issued by Mr T T Mboweni, Governor of the South African Reserve Bank

6 December 2007

31 January 2008

10 April 2008
Boxes


Figures


Remuneration per worker, labour productivity and unit labour cost in the formal


South African Reserve Bank
Monetary Policy Review May 2008
Tables


South African Reserve Bank

Monetary Policy Review May 2008
Monetary Policy Review
Introduction
The South African economy continues to be impacted by a series of supply-side shocks
emanating from the international energy and food markets. The effect of these shocks
on the inflation environment is posing problems for economies around the world and a
number of inflation-targeting countries are currently above their inflation targets. In
certain advanced economies the response to these shocks has been complicated by
the simultaneous effects of the banking and credit crisis that originated in the United
States (US) sub-prime market.
The electricity price increase granted to Eskom in April and the possibility of further
increases, together with the weakening of the exchange rate of the rand, have also
worsened the domestic inflation outlook in the period since the publication of the
previous Monetary Policy Review in November 2007. Collectively, despite signs that the
economy is responding to the tighter monetary policy stance, these international and
domestic developments have contributed to deteriorating inflation expectations and
signs of generalised inflation pressures emerging in the economy.
As usual, the Monetary Policy Review analyses inflation developments and the factors
that have impacted on inflation, followed by an assessment of recent monetary policy
developments and a discussion of the outlook for inflation. Four topical issues are
focused on in the boxes. The first box notes the recent changes announced by Statistics
South Africa (Stats SA) which impact on the main inflation indices, while the second
provides a global perspective on the surge in agricultural commodity prices. The third
box reflects on the performance of inflation-targeting countries in the light of the global
food and energy shocks, and the final box considers the impact on the global economic
growth outlook of a slowdown in the US economy.
Recent developments in inflation
This section reviews recent trends in the main inflation indices and analyses
developments in the main factors impacting on inflation in South Africa.
The evolution of indicators of inflation
The measure of inflation targeted by the South African Reserve Bank (the Bank), namely
the year-on-year increase in the consumer price index excluding mortgage interest cost
for metropolitan and other urban areas (CPIX), has remained above the inflation target
range of 3 to 6 per cent since April 2007 (Figure 1). Since the publication of the previous
Monetary Policy Review, when the latest available rate (for September 2007) was
6,7 per cent, the CPIX inflation rate has risen continuously to reach 10,1 per cent in
March 2008. Developments in food and energy prices have been the most important
factors driving this increase.
It is important to note that recent changes introduced by Stats SA regarding the treatment
of clothing and footwear prices in the consumer price indices (discussed in greater detail
in Box 1), in combination with Stats SA’s policy of non-revision of these indices, have
created a transitional upward bias in the aggregate indices’ annual rates of change for the
period from January to December 2008. For this period, Stats SA will publish a monthly
estimate of the extent of upward bias. For the year-on-year CPIX inflation rates indicated

in Figure 1 this upward bias was approximately 0,17 of a percentage point in January,
0,18 of a percentage point in February and 0,20 of a percentage point in March 2008.
Figure 1 also shows the year-on-year inflation rate measured in terms of the headline
consumer price index for metropolitan areas (CPI). The CPI inflation rate increased from
7,2 per cent in September 2007 to 10,6 per cent in March 2008.
The contributions of the various components of the CPIX to the overall inflation rate are
presented in Table 1. As mentioned earlier, food and energy prices have been notable in
this regard. The weighted contribution of food prices to the overall 12-month CPIX inflation
rate, which was 3,2 percentage points in September 2007, rose to 4,4 percentage points
in March 2008. The contribution of transport prices increased from 0,4 of a percentage
point in September 2007 to 2,1 percentage points in March 2008.
Table 1
Contributions to CPIX inflation
Percentage change over twelve months* and percentage points

Sep
Oct
Nov
Dec
Jan
Feb
Mar

Of which:

Medical care and health expenses ....

Source: Statistics South Africa
Monetary Policy Review May 2008
South African Reserve Bank
Percentage change over twelve months

CPI
CPIX
Figure 1
Consumer price inflation: CPIX and CPI
Source: Statistics South Africa
South African Reserve Bank

Monetary Policy Review May 2008
Box 1 Recent changes to the main inflation indices
Statistics South Africa (Stats SA) has recently released information on changes that impact on the
consumer and producer price indices that are a key input into the monetary policy process in South
Africa. This box provides a brief overview of the changes and refers those readers requiring more
detail to relevant publications.
The first of the releases is an explanatory note (Stats SA, 2008a) that relates to a change in the
treatment of clothing and footwear prices in the CPI and CPIX, namely that the indices be
compiled on the basis of clothing and footwear prices excluding items on sale. This change was
mooted by Stats SA in September 2007, and first implemented in the January 2008 data
(published on 27 February 2008). The change was made in order to correct a downward bias in
the price changes of clothing and footwear, resulting from the inclusion of items on sale, which
was identified during 2007. Stats SA points out that the bias was inconsistent with evidence
available from clothing retailers and upward price pressures in other sectors, and at variance with
the international best practice of not including in the CPI prices of goods with limited availability.
The introduction of the change in the treatment of clothing and footwear prices together with Stats
SA’s policy of not revising the CPI and CPIX indices has, however, created an upward bias in the
annual rates of change of the indices for the period January – December 2008. A monthly estimate
of the extent of this temporary upward bias will be provided by Stats SA during this period.
The second release provides details regarding the updating of the producer price index (PPI)
(Stats SA, 2008b). From January 2008, the PPI data released by Stats SA are based on an
updated set of weights. These new weights are based on updated information as well as on
changes in the approach used to derive the weights at the higher industry grouping level, that
is, Standard Industrial Classification (SIC) digit levels 1 to 3. A major change is that the weights
used in the old PPI were based on the relative importance of sales in the higher groupings,
whereas in the new PPI the higher groupings are weighted by the corresponding proportion of
value added as measured in the national accounts for the purposes of calculating gross
domestic product by origin. In this way the importance of each industry in the PPI is proportional
to the value added. Table B1.1 compares the new and the old weights in the PPI for the higher
industry grouping level.
Table B1.1: Comparison of old and new weights in the PPI
Old weights
New weights
based on sales
based on value
added and
new information

* Sawmilling (weight of 0,36 in old PPI) was reclassified from manufacturing to forestry
Source: Statistics South Africa (2008b)
The nature of these changes means that the new PPI is not completely comparable with its
predecessor and needs to be analysed with caution. In addition to changes related to the
weights in the PPI, the presentation of the headline PPI has also changed. In terms of the old
PPI methodology, the headline PPI was a weighted average of the indices for domestic and
imported prices, whereas the new headline PPI is based on the prices of South African output
whether that output is sold in the domestic market or the export market. Import prices will have
an indirect impact through the prices of imported inputs purchased by producers. The gold
price, which was excluded from the old PPI in an attempt to avoid its price fluctuations
dominating those of other products, is now included in the mining category of the new PPI.

World agricultural commodity prices have risen sharply since late 2006, as discussed in
Box 2. For South Africa, Figure 2 shows that year-on-year inflation in food prices
increased from 12,0 per cent in September 2007 to 15,6 per cent in March 2008. The
prices of grain products and milk, milk products, and eggs continued to accelerate
strongly, with inflation rates rising from 17,0 to 22,9 per cent and 19,5 to 25,5 per cent,
respectively, over this period. Vegetable prices rose at a rate of 17,6 per cent in March
2008, below their recent peak of 27,5 per cent in November 2007, and meat price
inflation averaged around 7 per cent between September 2007 and March 2008.
The movements in transport prices were largely the result of fluctuations in domestic petrol
prices. Figure 3 examines recent developments in the price of 95 octane unleaded petrol
in Gauteng Province. Since September 2007, when the price was reduced by 10 cents to
R6,91 per litre, the price of petrol has increased by a cumulative R2,55 per litre to reach
R9,46 per litre in May 2008. Figure 3 also decomposes the price movement for each
Monetary Policy Review May 2008
South African Reserve Bank
According to Stats SA, these revisions are necessary to make sure that (1) the weighting pattern is
not obsolete; (2) the reporting establishments continue to be the most representative of the industries
surveyed; and (3) the products chosen are those that are most traded and that there is suitable
representation of emerging products in the standard basket. Stats SA argues that these changes are
consistent with international best practice and that they achieve a greater degree of consistency
between the PPI and the system of national accounts than has been the case in the past.
References
Statistics South Africa. 2008a. “Explanatory note to analysts on the method used to change the
treatment of clothing and footwear prices in the Consumer Price Index (CPI)”, March. Available
online at:
___. 2008b. “Note on updating of South Africa’s producer price index”. Statistical release P0142.1,
February. Available online at:
Stats SA see Statistics South Africa.
Percentage change over twelve months
-10
-5

All food items

Meat

Source: Statistics South Africa

Vegetables

Grain products


CPIX

Milk, milk products and eggs
Figure 2
CPIX and food inflation
month, highlighting the contributions of movements in international product prices and in
the exchange rate, and shows that these factors have acted together in recent months to
place upward pressure on the petrol price. The net under recovery of 207,3 cents per litre
since September 2007 resulted from a 162,6 cents per litre contribution from international
product prices reinforced by a 44,7 cents per litre contribution from exchange-rate
movements. The pump price of petrol was raised by 66 cents per litre in April (this included
a combined 11 cents per litre increase in the fuel tax and Road Accident Fund levy), and
by 55 cents per litre in May (this included a 20 cents per litre increase in the slate levy, a
2,5 cents per litre increase in the service differential and a 1,5 cents per litre incremental
inland transport recovery levy).
Figure 4 shows the effect of excluding energy and food prices from the year-on-year
CPIX inflation measure. Energy prices, which provided slight downward pressure on
CPIX inflation between July and September 2007, have had a less benign impact since
October. Excluding energy prices, CPIX inflation would have been lower, increasing from
7,0 per cent in October 2007 to 8,5 per cent in March 2008. The effect of excluding food
prices from the CPIX is also to lower the resultant inflation rate, although the impact is
more significant and has been more persistent than in the case of energy prices. The
inflation rate for CPIX excluding food prices rose from 4,8 per cent in September 2007
to 8,0 per cent in March 2008. When both energy and food prices are excluded from
the CPIX, the resulting inflation rate increased from 4,9 per cent in September 2007 to
5,6 per cent in March 2008.
South African Reserve Bank

Monetary Policy Review May 2008
Cents per litre
Cents per litre
Figure 3
South African petrol price

Feb Mar Apr May Jun Jul
Jan
Feb Mar Apr May
Jan

Gauteng price of 95 octane unleaded petrol

Price change

Over (-)/under (+) recovery
Source: Central Energy Fund

Sep Oct Nov Dec
Aug
-60
-40
-20

Movement in international product prices
Movement in the exchange rate

Monetary Policy Review May 2008
South African Reserve Bank
Percentage change over twelve months

CPIX

CPIX excluding energy prices

CPIX excluding food prices

CPIX excluding food and energy prices
Sources: Statistics South Africa and SARB calculations
Figure 4
The effect of food and energy prices on CPIX inflation

Box 2 Food prices: A global perspective
In 2006 and 2007 world agricultural commodity prices rose sharply for nearly all major food and feed
groups. Data from the United Nations Food and Agriculture Organization (FAO) show that in 2007 the
FAO Food Price Index averaged 157, representing a 23-per-cent increase from 2006 and 34 per cent
from 2005. The increases in the prices have been more pronounced for dairy products which, on
average, rose by nearly 80 per cent in 2007. The prices of oilseeds increased by 50 per cent in 2007 and
those of grains by 42 per cent. While the prices of wheat, maize and other agricultural commodities have
surged since late 2006, the significant increases in rice prices started only in January 2008 and had
doubled by the end of March after being boosted by strong Asian, Middle Eastern and African demand.
Several important supply and demand factors were the main contributors to global food inflation. On
the supply side, sharp increases in dairy and wheat prices were due to a drought in Australia, and tight
dairy supplies were due to low inventories in the European Union (EU). Cereal output in eight major
exporting countries declined by 4 per cent in 2005 and 7 per cent in 2006, before recovering in 2007
due to higher prices. In addition, the high feed prices have raised the cost of animal production and
resulted in increases in meat prices. Moreover, an outbreak of the “blue-ear disease” in China
significantly reduced pork stocks and pushed up domestic meat prices by over 50 per cent in August
2007. The FAO expects a significant fall in global oilseed production, due to a shift of plantings from
soya beans to maize in northern hemisphere countries. This is likely to increase the prices of soya
beans and oilseeds further.
Increases in petroleum prices have raised the cost of producing and transporting agricultural
commodities. Freight rates also doubled within 12 months beginning February 2006 due to stretched
shipping capacity, port congestion and longer trade routes. Increases in the prices of fertilisers due
to rising energy prices have also increased the cost of producing food.
According to the FAO (2007), the recent episodes of price increases differ from the past in that
inventories are being kept at low levels. Global rice stocks, for example, are at their lowest level since
1976. When production shortages occur at a time when inventories are low, as happened in 2005
and 2006 for cereals, international markets tend to become tighter and the magnitude of price
changes becomes magnified when unexpected events occur.
On the demand side, the biofuels market, which grew from 154,84 million barrels in 2000 to about
516,13 million barrels in 2007,1 has become a significant source of demand for some agricultural
commodities such as sugar, maize, oilseeds and palm oil. These commodities, which have
traditionally been consumed as food, are now also being grown as inputs for biofuel production.

See Coyle (2007).
South African Reserve Bank

Monetary Policy Review May 2008
Another demand-side factor is that large, dynamic emerging markets such as China, India, Brazil and
Russia have become an important source of global food demand growth. Owing to higher
responsiveness of food demand to income growth, growth in per capita incomes in these countries
directly translates into increased consumption, especially for high value-added food items such as
meat and dairy products.
Beyond the demand and supply factors, other contributing factors to price increases are the interlinkages and spill-over effects between various commodity markets. For instance, soaring maize
markets contributed to keeping oilseed prices at high levels as maize plantings expanded at the
expense of oilseed plantings (IFAD, 2008).
Table B2.1 presents a sample of countries in which in most instances2 food inflation has been on the rise
between 2006 and 2007. For instance, in emerging markets such as South Africa and developed
countries such as the United States, Japan and the euro area, food inflation has been higher than
headline inflation since 2006. Table B2.1 indicates that China, Indonesia and Tanzania have large food
weights in their consumer price indices (CPIs) and they are therefore more sensitive to food price shocks.
Table B2.1: Headline and food inflation in selected countries
Per cent
Country

China:

Euro area:

Hungary:

Indonesia:

Japan:

New Zealand:

South Africa:

Tanzania:

United States:

Venezuela:

Note: Weight of food prices in CPI in brackets
*
Food and non-alcoholic beverages
**
Food excluding soft drinks
Sources: Bloomberg and national statistical agencies
Within countries that are net food importers, poor households are likely to be hurt more by higher
food prices, because they spend a higher proportion of their disposable income on food. Of particular
concern to low-income countries are price increases of oilseeds and grains that constitute a large
share of their citizens’ diets. According to Rosen and Shapouri (2007), in low-income Asian countries,
grains account for an average of 63 per cent of the diet and in North Africa about 60 per cent. In
sub-Saharan Africa, grains account for nearly half of the calories consumed.
Policy responses to limit the impact of rising prices have been varied.3 For instance, the government in
China has raised subsidies for wheat and rice and has introduced export duties of 20 per cent on
wheat, buckwheat, barley and oats, and 5 per cent on rice, maize, sorghum, millet and soya beans. A
36-per-cent import duty on wheat flour has been removed in India. In March the Vietnam government
announced that it would cut rice exports by nearly a quarter in 2008. In the same month India effectively
banned the export of all but the most expensive grades of rice. Egypt announced that it would impose
a six-month ban on rice exports, starting in April 2008, and Cambodia banned all rice exports except
those exported by government agencies. In Japan, authorities have announced the establishment of a
department responsible for food security. In South Africa, the government made adjustments to the

Exceptions include Hungary,
Indonesia, Japan and Tanzania.

The contents of this
paragraph are based on FAO
(2008).

Figure 5 presents the inflation rates for the goods and services categories of CPIX
inflation. Goods prices continue to place upward pressure on CPIX inflation, with the yearon-year inflation rate for goods prices rising from 7,2 per cent in September 2007 to
12,4 per cent in March 2008. The movement in goods price inflation can be attributed
Monetary Policy Review May 2008
South African Reserve Bank
amounts paid in social grants so as to mitigate the impact of rising food prices. In Brazil the
government is considering a reduction or removal of the 10-per-cent import tax on wheat from
countries other than Argentina. The Moroccan government has cut wheat import tariffs to the lowest
level ever. As far as Europe is concerned, the EU has removed the 10-per-cent compulsory set-aside
requirement and subsequently suspended cereal import duties (excluding oats, buckwheat and millet)
as from December 2007 until the end of the current marketing season in June 2008.
References
Bloomberg databases. Accessed on 16/04/2008.
Coyle, W. 2007. “The future of biofuels: a global perspective”. Amber Waves, Vol. 5, No. 5,
November, pp. 24 – 29.
FAO see Food and Agriculture Organization.
Food and Agriculture Organization. 2007. Food outlook: global market analysis, November.
Economic and Social Department.
___. 2008. Crop prospects and food situation. No. 1, February. Global Information and Early
Warning System.
IFAD see International Fund for Agricultural Development.
International Fund for Agricultural Development. 2008. “Growing demand on agriculture and rising
prices of commodities”. Paper prepared for the Round Table organised during the Thirty-first
Session of IFAD’s Governing Council, 14 February 2008. Trade and Markets and Agriculture
Development Economics Divisions of the Food and Agriculture Organization of the United Nations.
OECD–FAO see Organisation for Economic Co-operation and Development–Food and Agriculture
Organization.
Organisation for Economic Co-operation and Development–Food and Agriculture Organization
2007. Agricultural outlook 2007–2016. OECD–FAO.
Rosen, S. and Shapouri, S. 2007. “Rising food prices intensify food insecurity in developing
countries”. Amber Waves, Vol. 6, No. 1, June, pp. 16 – 21.
Percentage change over twelve months

Goods
Services
CPIX

Figure 5
CPIX: Goods and services inflation
Source: Statistics South Africa
largely to the developments in the food component, which has a weight of 38,7 per cent
in the goods index. Services inflation increased more modestly from 5,8 per cent to
5,9 per cent over the same period.
Administered prices have a weight of 20,01 per cent in the CPIX, with petrol prices
contributing 5,08 percentage points and electricity prices 3,55 percentage points. The yearon-year inflation rate for the overall administered price index (API) amounted to 14,8 per cent
in March 2008 compared with 5,8 per cent in September 2007 (Figure 6). However,
excluding the petrol component, the inflation rate for the remaining administered prices
remained stable at around 7 per cent between September 2007 and March 2008.
The weighted contributions of the various components to CPIX administered price inflation
in the period under review are provided in Table 2, where the influence of petrol price
increases is clearly evident. In September 2007, petrol prices contributed 1,0 percentage
point to year-on-year administered price inflation of 5,8 per cent. By March 2008 this
contribution had risen to 9,9 percentage points to an overall rate of 14,8 per cent. The
recent electricity price increase of 14,2 per cent granted to Eskom from 1 April 2008 has
not as yet been included in the consumer price indices.
Table 2
Contributions to administered price inflation
Percentage change over twelve months* and percentage points

Sep
Oct
Nov
Dec
Jan
Feb
Mar

Of which:

Source: Statistics South Africa
South African Reserve Bank

Monetary Policy Review May 2008
Percentage change over twelve months

Administered price index (API)

API excluding petrol

CPIX
Sources: Statistics South Africa and SARB calculations
Figure 6
CPIX and administered prices

In March 2008, Stats SA released a PPI based on a new basket and a change in
methodology. The new index has a significantly lower weight for manufacturing and an
approximate doubling in the weights of mining and quarrying, and of electricity, gas and
water. The price of gold is now included in the mining category of the index. The new
headline PPI is based on the prices of South African output sold in the domestic market
or exported, whereas the previous index was a weighted index of domestic and
imported prices. These changes mean that the headline PPI is likely to be a less reliable
guide to future inflation trends and that focusing on particular components of the index
may be more informative in this regard. The headline PPI inflation rate increased from
10,4 per cent in January 2008 to 11,8 per cent in March.
Factors affecting inflation
Recent developments in some of the main drivers of inflation in South Africa, including
domestic and international factors, are reviewed in this section. The outlook for these
variables and therefore for inflation is discussed in a later section.
International economic developments
The recent credit turmoil centred in the US and parts of Europe began to slow the
global economic expansion in the fourth quarter of 2007. According to the most
recent International Monetary Fund (IMF) data, the global economy recorded growth
of 4,9 per cent in 2007 (Table 3). Economic growth in the US slowed notably and
growth also slowed in western Europe, while confidence indicators began
deteriorating. Despite some slowing of export growth, emerging-market and
developing economies have continued to expand strongly, led by China and India.
These economies have benefited from the strong momentum of domestic demand,
more disciplined macroeconomic policy frameworks and, in the case of commodity
exporters, from higher commodity prices.
Growth in the US began to slow in the final quarter of 2007 due to a continuing
sharp drop in residential construction, considerable weakness in final demand
following the continued contraction in residential investment, a rundown of
inventories and a deceleration in exports. In Japan, the expansion accelerated
towards the end of 2007, after having lost some momentum mid-year to record an
annual growth rate of 2,1 per cent on the back of improved business investment and
consumer spending. For the euro area, recent economic data indicate that real
output growth moderated in the final quarter of 2007, mainly due to a contraction in
consumer and government expenditure. Economic growth of 2,6 per cent was
recorded for the year and overall eurozone consumer price inflation of 2,1 per cent
was still slightly above the European Central Bank’s (ECB) target ceiling. In the
United Kingdom (UK), revised estimates show that real gross domestic product
(GDP) grew by 3,1 per cent in 2007. Final domestic demand was revised
downwards as the negative impact of a weakening housing market on some
components of final demand was greater than expected.
Developing Asia recorded sustained strong growth in 2007. The Chinese economy
registered its fastest growth in 13 years, expanding by 11,4 per cent in 2007, and
thereby exceeding a rate of 10 per cent for the fourth consecutive year. India’s economy
recorded growth of 9,2 per cent in 2007. Growth in Africa remained strong in 2007, with
an expansion in real GDP of 6,3 per cent being underpinned by high commodity prices,
improved economic policies and fairly limited exposure to international financial market
turmoil. The 6,3 per cent inflation rate in 2007 was marginally lower than the 6,4 per cent
recorded the previous year.
Monetary Policy Review May 2008
South African Reserve Bank
Table 3
Annual percentage change in real gross domestic product and
consumer prices

Share of
Real GDP
Consumer
global real GDP*
prices

Other emerging-market and developing countries

GDP shares based on the IMF’s purchasing-power-parity valuation of country GDPs for 2007
**
Zimbabwe excluded
Source: IMF World Economic Outlook, April 2008
Oil prices
International crude oil prices continued to rise in the period under review. From around
US$90 per barrel at the beginning of November 2007, Brent crude oil prices remained
volatile throughout December 2007 and reached levels of around US$98 per barrel in
early January 2008 (Figure 7). After declining thereafter in January and at the beginning
South African Reserve Bank

Monetary Policy Review May 2008
Figure 7
Price of Brent crude oil

J M M J S N J M M J S N J M M J S N J M M J S N J M M J S N
US dollar per barrel

Brent crude spot price

Futures prices (9 April 2008)

Futures prices (5 May 2008)
Source: Bloomberg

of February, the second week of February saw the start of a renewed upward trend. The
oil price initially increased due to concerns about supplies from Venezuela, following
threats by the country’s president to cease oil supplies to the US, and later on due to
statements made by Iran’s oil minister that the Organization of the Petroleum Exporting
Countries (OPEC) would consider reducing production. Reports of increased violence in
Nigeria and speculative oil demand were also responsible for keeping the oil price at levels
between US$98 and US$100 per barrel in the second half of February. Supply disruptions
in Ecuador and the UK also contributed to the rise in the oil price in late February.
The oil price remained volatile in March 2008. It rose initially on the announcement of
unexpectedly low US crude-oil inventories and OPEC’s decision on 5 March 2008 to keep
its output targets unchanged, and subsequently on a weaker US dollar and projections that
global oil demand for 2008 would remain robust. After reaching levels of around
US$108 per barrel in mid-March, the oil price then declined due to heightened uncertainty
regarding the overall economic outlook after the US Federal Reserve decided to mediate
the purchase of Bear Stearns and then reduced its policy rate. The price of Brent crude oil
continued to retreat to end the month at around US$100 per barrel, despite a brief rally on
lower-than-expected fuel inventories, geopolitical concerns and resumed dollar weakness.
In late April, Brent crude oil prices rose significantly to reach US$116 per barrel, as further
US dollar weakness and rumours of an attack on an oil pipeline in Nigeria stoked speculative
oil demand, but retreated once more to end the month around US$110 per barrel.
Central bank interest rate developments
Headline inflation has increased since mid-2007 in both advanced and emerging-market
economies. Core inflation has also generally drifted upwards, but in the US the Federal
Reserve has been cutting interest rates in response to increasing downside risks to
activity, while policy has been on hold in the euro area and Japan (Table 4).
Since the beginning of 2007, a group of the world’s biggest banks have recorded asset
writedowns and credit losses of US$232 billion, and the Federal Reserve has continued
to cut its policy rate in an attempt to forestall losses in the credit and equity markets. On
16 March 2008, the Federal Reserve decided to lend to investment banks from the
discount window, a privilege previously reserved for more tightly regulated commercial
banks. It also expanded the types of eligible collateral in an effort to provide liquidity to
strained markets such as mortgage-backed securities. The Federal Reserve’s Term
Securities Lending Facility that lends out US Treasury bills against collateral to primary
dealers in an effort to improve liquidity in repurchase markets was also expanded. The
US Federal Open Market Committee lowered its target for the federal funds rate by a
further 25 basis points on 30 April 2008 – a cumulative reduction of 325 basis points
since August 2007. The Bank of England cut its key interest rate by a quarter of a
percentage point to 5 per cent on 10 April 2008 amid falling house prices and tightening
credit standards as the continuing money-market turmoil looked set to dent UK
economic growth. Official interest rates were also lowered in Canada, Hong Kong, Israel
and Turkey. However, annual consumer price inflation continued to accelerate in most
countries, including emerging-market economies in general, and recent data suggest
that price pressures will remain strong in the coming months.
In many countries where food and energy represent a higher share of consumption
baskets and/or capacity constraints have been more of a concern, central banks have
continued to tighten their policy stances. Monetary policy has been tightened in
Australia, the Czech Republic, Hungary, Poland, Russia, Sweden, Taiwan, Iceland and
Monetary Policy Review May 2008
South African Reserve Bank
Brazil since November 2007. The Central Bank of Iceland raised its key rate by 50 basis
points to a record 15,5 per cent to support its depreciating currency and tame persistent
inflation pressures. The decision follows a 1,25 percentage-point rate increase on
25 March. Brazil’s central bank raised its benchmark interest rate more than expected
by 50 basis points to 11,75 per cent from a record-low 11,25 per cent (the first increase
in three years) as quickening economic growth threatened to stoke inflation. A surge in
food prices and rising consumer demand have pushed annual inflation in Brazil from an
eight-year low of 3 per cent in March 2007 to a two-year high of 4,7 per cent in March,
above policy-makers’ year-end target for a third month.
Table 4
Selected central bank interest rates
Per cent
Countries
1 Jan 2007
5 May 2008
Latest decision
(change in
percentage points)
5,25
2,00
30 Apr 2008
(-0,25)
0,25
0,50
30 Apr 2008
(0,00)
3,50
4,00
10 Apr 2008
(0,00)
5,00
5,00
10 Apr 2008
(-0,25)
4,25
3,00
22 Apr 2008
(-0,50)
3,50
4,00
6 Jun 2007
(+0,25)
3,00
4,25
24 Apr 2008
(+0,25)
1,50 – 2,50
2,25 – 3,25
13 Mar 2008
(0,00)
6,25
7,25
1 Apr 2008
(0,00)
4,50
8,25
24 Apr 2008
(0,00)
4,50
3,25
28 Apr 2008
(0,00)
6,12
7,47
20 Dec 2007
(+0,18)
6,75
3,50
2 May 2008
(-0,25)
9,75
8,00
3 Apr 2008
(0,00)
3,50
3,50
29 Apr 2008
(0,00)
4,50
5,00
7 Mar 2008
(0,00)
2,75
3,50
27 Mar 2008
(+0,125)
5,00
3,25
9 Apr 2008
(0,00)
7,25
7,75
29 Apr 2008
(0,00)
13,25
11,75
16 Apr 2008
(+0,50)
5,25
6,25
13 Mar 2008
(0,00)
7,00
7,50
18 Apr 2008
(0,00)
2,50
3,75
8 Feb 2008
(+0,25)
8,00
8,25
28 Apr 2008
(+0,25)
4,00
5,75
30 Apr 2008
(0,00)
11,00
3,75
29 Apr 2008
(+0,25)
17,50
15,25
17 Apr 2008
(0,00)
13,30
15,50
10 Apr 2008
(+0,50)
Source: National central banks
Exchange rate developments
The South African rand has depreciated markedly since the publication of the previous
Monetary Policy Review in November 2007 (Figure 8). Despite the US dollar having
weakened against a range of currencies, the rand depreciated against the US dollar by
approximately 16 per cent from R6,53 on 1 November 2007 to R7,59 on 30 April 2008.
During the same period, the rand depreciated by around 25 per cent against the euro,
weakening from R9,43 to R11,82 to the euro. When measured against a basket of
13 currencies, that is, the nominal effective exchange rate of the rand (NEER), the rand
depreciated from 81,6 index points on 1 November 2007 to 67,6 index points on 30 April
2008, representing a decline of 17,1 per cent.
South African Reserve Bank

Monetary Policy Review May 2008

The exchange-rate movements in this period may partly reflect increased risk aversion
by investors towards emerging markets in the wake of the sub-prime crisis. Electricity
supply constraints may also have affected investor perceptions regarding South Africa’s
growth prospects. In addition, there appears to be an increased risk premium that
investors require for holding the rand, given its volatility and increasing concerns about
the size of the South African current-account deficit, notwithstanding the fact that the
deficit has so far been comfortably financed by capital inflows on the financial account
of the balance of payments.
The net inflow of capital in the fourth quarter of 2007 amounted to R54,2 billion, bringing
the cumulative net inflow of capital to R192,8 billion for 2007 as a whole. Foreign direct
investment into South Africa recorded an inflow of R40,2 billion in 2007, following an
outflow of R3,6 billion in 2006. Increased risk aversion by international investors,
however, has significantly lowered foreign portfolio inflows to R2,9 billion in the fourth
quarter of 2007 from an inflow of R33,7 billion in the third quarter.
Labour markets
Figure 9 shows that wage inflation, measured by the year-on-year rate of increase in the
nominal remuneration per worker in the non-agricultural sectors, remained relatively flat
between the third and fourth quarters of 2007, slowing slightly from 7,5 per cent to 7,1 per
cent. The combination of this decline in wage inflation and a slight increase in the growth in
Monetary Policy Review May 2008
South African Reserve Bank
Index: 2000=100 (foreign currency per rand)
Rand per euro
Rand per US dollar
Figure 8
Exchange rates of the rand

Mar May
Jul
Sep Nov
Jan

Nominal effective exchange rate of the rand (NEER)

Rand per US dollar

Rand per euro (right-hand scale)

Mar May
Jul
Sep
Nov Jan
Mar
Jan
labour productivity during the same period resulted in a marginal decline in the growth in unit
labour cost from 4,6 per cent to 4,3 per cent between the third and fourth quarters of 2007.
According to Andrew Levy Employment Publications, wage settlements averaged 7,3 per
cent in 2007 compared with 6,5 per cent a year before (Figure 10). In the first quarter of
2008, wage settlements increased to 7,8 per cent. Given the recent increase in inflation
expectations, it is expected that wage settlements will move upwards during 2008.
South African Reserve Bank

Monetary Policy Review May 2008
Percentage change over four quarters

Figure 9
Remuneration per worker, labour productivity and

unit labour cost in the formal non-agricultural sector

Nominal unit labour cost

Remuneration per worker

Labour productivity


Sources: Statistics South Africa and SARB calculations

Per cent
Figure 10 Average annual inflation and wage settlements

CPI


* Data for 2008 are for the first quarter
Sources: Andrew Levy Employment Publications and Statistics South Africa

Average wage settlements
CPIX

Demand and output
The South African economy recorded an annualised rate of growth of 5,3 per cent in the
fourth quarter of 2007, compared with a revised annualised rate of 4,8 per cent in the
third quarter (Table 5). For 2007, the real GDP growth rate was 5,1 per cent, compared
with 5,4 per cent in 2006. This represented the fourth consecutive year in which growth
was either close to or above 5 per cent.
Table 5
Growth in real gross domestic product and expenditure components
Per cent*

Year
1st qr
2nd qr
3rd qr
4th qr
Year
Final consumption expenditure:

Quarterly data refer to quarter-on-quarter growth at annual rates of seasonally adjusted data
**
Constant 2000 prices
The robust growth in the fourth quarter of 2007 can be attributed to a marked
acceleration in growth in real value added by the secondary sector. This sector grew at
an annualised rate of 8,1 per cent in the fourth quarter, compared with only 0,6 per cent
in the third quarter of 2007. The strong growth in the secondary sector reflected the
improved performance of the manufacturing sector, which contributed about
1 percentage point to real economic growth in the fourth quarter of 2007. This was
mainly the result of a strong recovery subsequent to industrial action in the third quarter
in the subsector that manufactures motor vehicles, parts and accessories. However,
measured on a calendar-year basis, growth in real value added by the manufacturing
sector still decelerated from 5,2 per cent in 2006 to 3,9 per cent in 2007.
A solid increase in agricultural production in the fourth quarter of 2007 was partly
neutralised by a contraction in the mining sector during the same quarter. Growth in real
value added by the primary sector accordingly slowed from an annualised rate of 4,5 per
cent in the third quarter of 2007 to 1,6 per cent in the fourth quarter. Real output in the
mining sector declined at an annualised rate of 1,7 per cent in the fourth quarter of 2007,
mainly due to a contraction in output volumes of gold and diamonds, as well as a
slowdown in platinum production. However, real value added by the agricultural sector
accelerated from an annualised rate of 5,8 per cent in the third quarter of 2007 to
10,5 per cent in the fourth quarter. Whereas agricultural production improved from a
decline of 7,9 per cent in 2006 to an increase of 0,3 per cent in 2007, mining production
contracted by 0,1 per cent in 2006 and by 0,6 per cent in 2007.
Growth in aggregate real gross domestic expenditure decelerated from an annualised
rate of 5,4 per cent in the third quarter of 2007 to 0,2 per cent in the fourth quarter. The
simultaneous slowdown in growth in final consumption expenditure by households and
government over this period, as well as a notable decline in inventory levels, more than
Monetary Policy Review May 2008
South African Reserve Bank
neutralised sustained vigorous growth in gross fixed capital formation. The growth in final
consumption expenditure by households slowed throughout 2007, recording 4,4 per
cent in the third quarter and 3,8 per cent in the final quarter of the year. The ratio of gross
fixed capital formation to GDP was 20,6 per cent in 2007 – its highest level since 1985.
In the external sector of the economy, real exports of goods and services surged by an
annualised 21,6 per cent in the fourth quarter of 2007. Export proceeds were boosted by
an increase in the physical quantity of exports and higher international commodity prices
during the fourth quarter of 2007. Real imports of goods and services rose moderately by
1,1 per cent in the corresponding quarter, with the result that South Africa’s trade deficit
almost halved. This outcome outweighed a further widening of the shortfall on the service,
income and current transfer account with the rest of the world over the same period.
Consequently, the deficit on the current account of the balance of payments shrank from
8,1 per cent of GDP in the third quarter of 2007 to 7,5 per cent in the fourth quarter. The
deficit was more than covered by net financial inflows from the rest of the world in the
fourth quarter. South Africa’s reserve position continued to strengthen with the gross gold
and other foreign reserves increasing from US$30,5 billion at the end of September 2007
to US$34,4 billion at the end of March 2008. The international liquidity position increased
from US$28,4 billion to US$33,1 billion over the same period.
Real-estate and equity prices
Figure 11 shows that the rate of increase in house prices has continued to slow since
September 2007. After pausing after mid-2006, the year-on-year rate of increase in the
nominal Absa House Price Index declined once more, from 14,4 per cent in September
2007 to 8,7 per cent in March 2008.4 The year-on-year change in the Standard Bank
House Price Index fell sharply from 10,2 per cent in October 2007 to -5,2 per cent in
March 2008. The median house price measured by this index was R550 000 in March
2008, compared with R580 000 in March 2007.
South African Reserve Bank

Monetary Policy Review May 2008
Percentage change over twelve months

-10

Absa House Price Index

Standard Bank House Price Index
Sources: Absa and Standard Bank
Figure 11 House prices

The Absa House Price Index
records the total purchase price
of houses in the 80 – 400 m2 size
category, valued at R2,9 million
or less in 2007 and for which
loan applications were approved
by Absa. The Standard Bank
House Price Index is based on
the median price of the full
spectrum of recorded house
prices.

Table 6 presents building statistics published by Stats SA, which suggest that economic
activity in the real-estate sector continued to moderate in 2007. The real value of
buildings completed increased by 9,8 per cent in 2007 compared with 21,4 per cent in
2006, mainly due to a significant slowdown in the growth of the real value of buildings
completed in the residential sector, which declined from 16,7 per cent to 1,5 per cent.
By contrast, the growth in the real value of buildings completed in the non-residential
sector was 48,8 per cent in 2007, up from 30,6 per cent in 2006.
Table 6
Real value of building plans passed and buildings completed in
larger municipalities
Annual percentage change

Building plans passed

Buildings completed

Source: Statistics South Africa
The total real value of building plans passed, which provides an indication of future
construction activity, declined by 2,7 per cent in 2007. This was the result of declines in
the real value of building plans passed for both the residential and non-residential sectors.
The real value of building plans passed for the residential sector contracted by 3,5 per
cent in 2007 after increasing by 2,7 per cent in 2006, and that for the non-residential
sector declined by 5,9 per cent in 2007 after increasing by 31,7 per cent in 2006.
Share prices on the JSE Limited (JSE) followed global trends in the period under review
by initially moving lower before recovering lost ground (Figure 12). The all-share index
Monetary Policy Review May 2008
South African Reserve Bank
Index
Index

FTSE/JSE all-share index
FTSE/JSE resources index (right-hand scale)
FTSE/JSE industrials index
FTSE/JSE financials index
Figure 12 Share price indices


(Alsi) traded above the 31 000 level in mid-October 2007 before declining in tandem
with global markets on concerns regarding the US sub-prime market to just above
25 000 late in January 2008. The Alsi was then buoyed by high commodity prices and
the recovery in global markets following the US Federal Reserve’s interest rate
reductions to trade around 31 000 once more in April. The record-high commodity
prices resulted in the JSE resources index increasing from around 59 000 at the
beginning of November 2007 to above 72 000 in mid-April 2008.
Fiscal policy
Notwithstanding the anticipated moderation in the pace of economic growth, the
South African Minister of Finance was able to present a surplus budget on 20
February 2008 (Table 7). According to the 2008 Budget Review, the estimated
budget balance for 2007/08 remains in surplus at R15,8 billion (or 0,8 per cent of
GDP), an amount of R5,1 billion more than what was estimated at the time of the
2007 Budget. The medium-term budget balance is projected to be surpluses of 0,6,
0,5 and 0,5 per cent of GDP in 2008/09, 2009/10 and 2010/11, respectively. In
terms of the structural or cyclically adjusted budget balance introduced in the 2007
Medium Term Budget Policy Statement, which factors in estimates of cyclical or
one-off revenues, the budget is broadly stable with a deficit averaging 1,2 per cent
of GDP over the next three years.
Table 7
Public finance data
R billions and per cent

Actual
Actual
Budget
Revised
Medium-term
estimates
estimates
National government

As percentage of GDP:

PSBR: Public-sector borrowing requirement
Source: National Treasury Budget Review 2008
The continued robust growth in tax revenue resulted in a revised main budget revenue
total of R558 billion for fiscal 2007/08, representing 2,5 per cent more than originally
budgeted. Expenditure was also revised upwards by about 1,5 per cent to
R542,1 billion for the same period. Debt service costs are projected to continue
decreasing over the medium term, declining from 2,6 per cent of GDP in 2007/08 to
1,9 per cent in 2010/11. The public-sector borrowing requirement (PSBR), which
represents the funds needed by the public sector to cover any deficit in financing its
own activities, has moved from a negative requirement to an average of 1,3 per cent
of GDP over the medium term.
South African Reserve Bank

Monetary Policy Review May 2008

Monetary conditions
The growth in monetary aggregates slowed over the period under review, despite having
moved higher in January 2008. The 12-month growth rate of the broad monetary
aggregate (M3) slowed from 25,8 per cent in August 2007 to 23,2 per cent in November,
then increased to 24,9 per cent in January 2008, before declining to 21,0 per cent in
March. The movements in the growth rates for the narrower aggregates followed a
similar pattern, with the M2 aggregate slowing to 20,0 per cent in March from 21,8 per
cent in January, and the M1 aggregate declining to 15,5 per cent from 31,4 per cent
over the same period.
Growth in total loans and advances to the private sector5 declined between September
2007 and March 2008 (Figure 13). The year-on-year growth in total loans and advances
to the private sector slowed from 25,2 per cent in September 2007 to 23,6 per cent in
March 2008. Adjusted for securitisation transactions, growth in this aggregate was
24,8 per cent in March. The growth in the other loans and advances category, reflecting
the usage of general loans and overdraft facilities by the corporate and household
sectors, has been the main contributor to total loans and advances in recent months,
although growth has slowed from its peak of 36,7 per cent in June 2007 to 29,5 per
cent in March 2008. Mortgage advances slowed in tandem with total loans and
advances, declining from 26,1 per cent in September 2007 to 23,2 per cent in March
2008, while the growth in instalment sale credit and leasing finance slowed from
15,2 per cent to 11,6 per cent over this period.
Monetary policy
In recent months, monetary policy has been facing a number of challenges. Inflation has
been rising relentlessly despite the tighter stance of monetary policy, and by February
CPIX inflation had reached 9,4 per cent. By the final quarter of 2007 there were clear
signs that monetary policy was beginning to have the expected impact on domestic
demand, but at the same time the economy was faced with a number of exogenous
Monetary Policy Review May 2008
South African Reserve Bank

Total loans and advances to
the private sector consist of
instalment sale credit, leasing
finance, mortgage advances,
overdrafts, credit card and
general advances. The first three
categories are referred to as
asset-backed credit, while the
last three are referred to as other
loans and advances.
Percentage change over twelve months

Figure 13 Growth in loans and advances
Other loans and advances
Total loans and advances
Mortgage advances
Instalment sale and leasing finance
-10

supply-side shocks that were impacting on the inflation outlook. Initially, these shocks
were confined to oil and food prices, but, more recently, electricity price developments
also compounded the problems. The higher trend of inflation outcomes has contributed
to a significant increase in inflation expectations and further increases in the repurchase
rate of 50 basis points in December 2007 and in April 2008 (Figure 14).
In general, there is little that monetary policy can do to avoid the first-round, or impact
effects of supply-side shocks. The standard response is for the monetary authorities to
allow for these one-off increases, but to react to any second-round or generalised effects
that may come through. If inflation expectations are well anchored, the required monetary
policy response could be relatively restrained. Similarly, the extent and duration of the
shock or relative price change would also have a bearing on the intensity of the policy
response. The problem facing the Monetary Policy Committee (MPC) is that it has not
been facing a single shock of limited duration. The MPC has had to deal with a multiplicity
of shocks of extended duration. For example, there has not been a sudden one-off
increase in oil prices. Rather, what has been seen is a significant and extended upward
trend in prices, which has almost consistently surprised on the upside. This has
necessitated significant upward revisions to forecasts of future oil-price developments on
numerous occasions. The severity of these developments has, in turn, adversely affected
inflation expectations which, in turn, contributes to more generalised inflation.
During the past three meetings of the MPC, there was a consistent deterioration of the
inflation forecast of the Bank, primarily as a result of upward revisions to the assumptions
relating to exogenous variables of the model. At the December 2007 meeting, it was
expected that inflation would peak at around 7,8 per cent in the first quarter of 2008 and
then decline to within the inflation target range by the end of 2008, and reach 5,2 per cent
by the final quarter of 2009. By January, the near-term forecast had deteriorated slightly, with
inflation expected to peak at 8,5 per cent in the first quarter of 2008. Although CPIX inflation
was still expected to return to within the target range by the end of 2008, the trajectory for
2009 was flatter around the 5,6-per-cent level. The forecast presented to the MPC at the
April 2008 meeting showed a significant deterioration. This forecast is reproduced later on
South African Reserve Bank

Monetary Policy Review May 2008
Per cent

Prime overdraft rate
Repo rate
3-month NCD rate
Figure 14 The repo and other short-term interest rates

in this Review. Not only was the peak expected to exceed 9 per cent, but inflation was now
expected to return to within the inflation target range only by the end of 2009.
The forecasts of the Bank were broadly in line with those of the private sector. Although
at the time of the April meeting the general consensus in the private sector was that
inflation would return to within the inflation target range during the first half of 2009,
subsequent revisions have also seen a more pessimistic outlook for inflation. The
forecasts are also complicated by the uncertainty relating to the extent of the additional
electricity price increase to be granted to Eskom.
At the December meeting, the committee noted that there was increasing evidence that
previous monetary policy actions were having a dampening effect on household
consumption expenditure. However, the MPC was concerned about the possible impact
of the higher inflation outcomes on inflation expectations. At that time, inflation
expectations, as reflected in the Inflation Expectations Survey conducted by the Bureau
for Economic Research (BER) at Stellenbosch University, had exhibited a slight
deterioration in the fourth quarter of 2007. Of significance was the fact that expectations
for 2009 had remained unchanged at 5,6 per cent. Indicators from the bond markets also
indicated that expectations appeared to be anchored within the target range, but
following an upward trend.
The main concerns of the MPC at the December 2007 meeting were the petrol, food
and electricity price prospects. The price of North Sea Brent crude oil was around
US$90 per barrel, and domestic petrol prices had increased by 43 cents per litre in
December. At that time there was still uncertainty relating to the outcome of Eskom’s
application for an 18-per-cent electricity price increase. Food was still a major
contributor to inflation trends, although futures prices indicated that some respite could
be expected during 2008. These factors contributed to the MPC’s decision to increase
the repurchase (repo) rate by a further 50 basis points in December.
Other developments were either seen to be neutral or favourable with respect to the
containment of inflation pressures. Household consumption expenditure continued to
show signs of moderation, and this was reflected mainly in motor vehicle and retail sales.
Credit extension to the private sector remained high, but appeared to be showing signs
of moderation. Asset-price growth also appeared to be restrained at that time, particularly
in the wake of global developments, which had a negative impact on domestic financial
and capital markets. House price increases were still positive but declining. The
supportive role of fiscal policy was confirmed by the renewed commitment to fiscal
prudence with the projection of fiscal surpluses in the coming years.
Domestic output growth appeared to be consistent with the potential growth rate of the
economy, while the exchange rate, although more volatile, was relatively unchanged.
The deficit on the current account of the balance of payments, which had widened to
8,1 per cent of GDP in the third quarter, continued to be adequately financed by capital
inflows. The global outlook at that time remained uncertain, although world inflation
appeared to be under control.
At the January 2008 meeting, the MPC decided to leave the repo rate unchanged,
despite the continued upward trend in inflation. As noted earlier, the central forecast of
the Bank had only shown a slight deterioration in the short term, and the longer-term
projection, which is of more concern to monetary policy, was relatively unchanged. The
main upside risks were the same as at the previous meeting, although the MPC’s
assessment was that the degree of upside risk had abated somewhat. International oil
Monetary Policy Review May 2008
South African Reserve Bank
prices had reached US$100 per barrel, but there was some expectation that the
impending global downturn could restrain the degree of upside price risk. Food prices
also remained a risk to the outlook, with some respite expected from the more
favourable weather conditions. Although the electricity price increase of 14,2 per cent
had been announced by the regulator, uncertainty still prevailed in this respect. An
important adverse development from an inflation perspective since the previous meeting
was the 7-per-cent depreciation of the trade-weighted rand exchange rate.
Despite these developments, the MPC felt there were sufficient offsetting developments
that would have a restraining impact on the inflation trend. Most significant was the
continued decline of household consumption expenditure growth, which was also being
dampened by negative wealth effects as evidenced in the 16-per-cent decline in the Alsi
on the JSE since October 2007 and the continued moderation in house-price increases.
Growth in credit extension also maintained its downward trend and wage growth appeared
to be consistent with the inflation target range. Risks to output growth were seen to be on
the downside, particularly in the light of emerging electricity supply constraints. At the same
time, the downside risks to global growth had increased.
By April, the risks to the inflation outlook had increased again, and the MPC decided to
raise the repo rate by a further 50 basis points. The prospect for a near-term return to
within the inflation target range had receded considerably. Furthermore, there were signs
that pressures on inflation were becoming more generalised, implying the emergence of
second-round effects. Oil prices had continued their upward trend and, combined with a
further 10-per-cent depreciation of the South African rand against most currencies,
resulted in a R1,27 cumulative increase in the domestic price of petrol in March and April.
Food price pressures were also exacerbated by the rand depreciation. The prospect of a
doubling of electricity prices by the middle of 2009 also had a marked impact on the risk
profile of the inflation outlook. Adding to these negative prospects was the most recent
inflation expectations survey which showed that expectations had deteriorated significantly
since the previous survey. Of particular concern was the deterioration in expectations for
the 2009 and 2010 periods, which indicates that respondents, on average, do not expect
inflation to return to within the target range over the medium term. These trends were also
evident in the increasingly higher wage settlements.
The MPC did highlight a number of factors counteracting these unfavourable trends, but
did not consider them to be sufficient to offset the upside risk to the forecast. These
factors were similar to those considered at the previous meeting. Of major significance
was the further slowdown in household consumption expenditure growth and evidence
of a moderation of output growth to rates below potential, as evidenced in a number of
surveys. The global growth scenario was also subject to further downward revisions,
while global inflation, while rising somewhat, appeared to be under control despite oil
and food price pressures.
When the MPC initially started on its tightening cycle in June 2006, the main concern
was the potential impact of high levels of domestic demand on inflation. Monetary policy
clearly has a direct role to play under such circumstances. The dilemma facing the MPC
more recently was that a succession of supply-side shocks had come to dominate the
inflation landscape. The discussion in Box 3 suggests that a number of inflation-targeting
countries currently face a similar challenge. While monetary policy cannot do much to
prevent these shocks from having first-round effects, the lack of a monetary policy
response could impact adversely on inflation expectations, which would then reinforce
the emergence of generalised price increases.
South African Reserve Bank

Monetary Policy Review May 2008

Monetary Policy Review May 2008
South African Reserve Bank
Box 3 Monetary policy challenges in uncertain times
The South African Reserve Bank is one of some 20 countries that have adopted the inflationtargeting (IT) framework since New Zealand became the first inflation targeter in 1990. The IT
framework has generally been found to have performed well. After countries had adopted IT, the
levels and volatility of inflation, and of interest rates, tended to decline, output volatility did not
worsen, and exchange rate pass-through moderated.6 More recently, however, there have been
challenges that have resulted in a number of inflation targeters missing their targets, raising
questions about the success of the framework.
As Tables B3.1 and B3.2 show, inflation outcomes in 2005 were within the targets of the vast
majority of IT countries. In January 2005, for example, all of the 7 industrialised countries in Table
B3.1 were within their targets, as were 8 of the 16 emerging-market inflation targeters in Table B3.2
(including South Africa).
Table B3.1: IT adoption dates and targets: Industrial countries
Per cent and percentage points (pp)
Country
IT adoption
Target
Point
Inflation as at
Inflation as at
date
range*
January 2005
March 2008
(per cent and pp)
(per cent)
(per cent)
(per cent)
Mar 1990


Oct 1992
+/- 1pp

1,5
2,5
Jan 1993
+/- 1pp

0,0
3,4
Apr 1993
2 – 3
Thick point
2,4
4,2
Mar 2001
+/- 1,5pp
2,5
4,0
8,7
Mar 2001
+/- 1pp**

A number preceded by a (+/-) indicates the tolerance level for a point target (in percentage points)
**
“Particular emphasis will be placed on any deviations outside the interval +/- 1 percentage point”
Sources: International Financial Statistics, various central banks’ inflation reports and websites
Table B3.2: IT adoption dates and targets: Emerging-market economies
Per cent and percentage points (pp)
Country
IT adoption
Target
Point
Inflation as at
Inflation as at
date
range*
January 2005
March 2008
(per cent and pp)
(per cent)
(per cent)
(per cent)


Czech Republic...
Jan 1998
+/- 1pp

1,7
7,1

+/- 1pp
2,5
4,0
4,1
Jun 1999
+/- 2pp
4,5
7,4
4,7
Sep1990
+/- 1pp

2,3
8,5
Sep1999

Feb 2000

May2000


+/- 0,5pp

3,1
3,9
Jan 2001
+/- 1pp

4,5
4,3
Jun 2001
+/- 1pp

4,1
6,7
Jan 2002
+/- 1pp

3,0
5,5
Jan 2002
+/- 1pp

8,4
6,4
Jul 2005
+/- 1pp

7,3
8,2
Aug2005
+/- 1pp

9,0
8,6
Jan 2006
+/- 2pp

9,5
9,2
*
A number preceded by a (+/-) indicates the tolerance level for a point target (in percentage points)
**
Colombia’s target for 2005 was 4,5 – 5,5 per cent
Sources: International Financial Statistics, various central banks’ inflation reports and websites

However, these trends
were observable worldwide in
the 1990s, and critics point
out that inflation targeters did
not perform better in this
regard than non-IT
industrialised countries such
as Germany and the US.
The outlook for inflation
The outlook, risks and uncertainties relating to some of the factors that determine the
outlook for inflation are presented in this section.
International outlook
Growth in world economic activity is projected to slow notably in 2008 in the wake of
ongoing financial market turbulence and increased risk aversion. After expanding by 4,9 per
cent in 2007, the global economy is expected to expand by 3,7 per cent in 2008 (revised
downwards from the forecast of 4,8 per cent made by the IMF in September 2007), and by
3,8 per cent in 2009 (Table 8). The risks to growth have become more skewed to the
downside than at the beginning of the year, predicated on the fallout from sub-prime
mortgages, weakness in consumer spending and lower productivity growth.
Table 8
IMF projections of world growth and inflation for 2008 and 2009*
Per cent
Real GDP
Inflation rates


Other emerging-market and developing countries....

IMF projections for 2008 as at September 2007 in parenthesis
**
Zimbabwe excluded
Source: IMF World Economic Outlook, April 2008
South African Reserve Bank

Monetary Policy Review May 2008
This situation has altered dramatically in recent months. Primarily as a result of inflationary pressures
emanating from the supply-side effects of developments in international energy and food markets,
many IT countries are currently in breach of their targets. As the tables show, according to the most
recent inflation data, 4 out of 7 industrialised country and 14 out of 16 emerging-market inflation
targeters are in breach of the upper end of their inflation target range or tolerance limit.
Does this mean that the IT framework has failed? The answer is no, although the current situation
provides an important test. Ideally, inflation targeters would prefer to keep inflation on target at all
times. However, the framework recognises that there may be instances when supply-side shocks
cause inflation to diverge from the target. The appropriate response of monetary policy in such
instances would be to ensure that second-round effects are minimised. The more anchored
expectations are, the more restrained the response will need to be. The success or failure of IT
depends on whether it allows IT countries to anchor expectations and facilitates a return to a low
and stable inflation environment over time, with as little cost to output as possible.

The growth projections for the US and some advanced economies have been reduced
significantly. Box 4 discusses the impact of a slowdown in the US on the global
economy. However, although growth forecasts have been lowered across the board,
with import growth of OPEC and other oil exporters soaring and the oil and commodity
investment boom continuing apace, the global expansion is projected to better
withstand the credit crisis-induced demand weakness in the US and a few other
developed countries than during previous crises.
Real GDP growth in the advanced economies is forecast at 1,3 per cent in 2008 and
2009 after having amounted to 2,7 per cent in 2007, while consumer prices are
projected to rise 2,6 per cent this year. This would be the highest inflation rate since
1995. The US economy faces increasing headwinds from a downturn in the housing
sector and US growth is projected to slow to 0,5 per cent in 2008, having been revised
downwards from the 1,9 per cent forecasted by the IMF in September 2007. Rising
prices for food, energy and other raw materials account for much of the pick-up in
inflation rates. Inflation in the US is expected to average 3 per cent in 2008, before
decelerating to 2 per cent in 2009.
In Japan, consumer and business sentiment has weakened. Japan’s growth is projected
to decelerate to 1,4 per cent in 2008 before rising slightly to 1,5 per cent in 2009.
Inflation of 0,6 per cent is projected for 2008 and 1,3 per cent for 2009.
For the euro area, the growth forecast for 2008 has been revised downwards by the IMF
to 1,4 per cent from the 2,1 per cent forecast in September 2007. Growth in 2009 is
projected to decline further to 1,2 per cent. Inflation in the euro area is expected to
average 2,8 per cent in 2008, well above the ECB’s preferred range.
In the UK growth is projected to decline to 1,6 per cent in 2008, having been revised
downwards from the 2,3 per cent forecasted by the IMF in September 2007. Inflation
in the UK is projected to accelerate to 2,5 per cent in 2008 before declining to 2,1 per
cent in 2009.
Outside the US and a few developed countries, growth is expected to generally hold up
well as a rotation in the source of global demand from credit-driven activity in the
borrowing countries to revenue-financed spending by the commodity exporters occurs.
Given the recent surge in commodity prices and continued problems in credit markets,
this rotation appears not to have run its course yet. A good indicator of this is Asian
exports which have remained robust overall, but are now decelerating to the US while
booming to the oil and commodity exporting countries. Consequently, global economic
activity continues to be supported by robust economic conditions in emerging-market
countries in general. However, weaker external demand, a further deterioration in
financing conditions and the tightening of monetary policy in a number of countries pose
downside risks to the growth outlook for these countries. Developing Asian nations have
also been adopting measures to ease the burden of mounting food and fuel prices on
the region’s poor, and inflation poses a greater challenge to the region’s economies than
the current financial turmoil.
China’s real GDP growth is projected to slow somewhat from the 11,4 per cent
expansion in 2007 to around 9,3 per cent in 2008. Inflation is projected to average
5,9 per cent in 2008 and 3,6 per cent in 2009. India is expected to record 7,9 per cent
growth in 2008 and 8,0 per cent 2009, while inflation is projected to decline to 5,2 per
cent in 2008 and 4,0 per cent in 2009. Growth of 8,2 per cent in 2008 would be the
lowest for developing Asia since 2002, down from 9,7 per cent in 2007.
Monetary Policy Review May 2008
South African Reserve Bank
Africa’s economic outlook remains positive given the continued favourable commodity
price outlook, regional macroeconomic stability, rising oil production and continued
capital inflows. The most important downside risks for growth in the region would
comprise heightened risk aversion by investors as a result of the tensions flowing from
the Zimbabwe elections and a worse-than-expected foreign demand outcome due to
spill-over effects flowing from the international financial turmoil.
The outlook summarised in Table 8 on is also reflected in other indicators. The
Global Manufacturing Purchasing Managers Index (PMI), produced by JPMorgan in
association with research and supply management organisations, continued its declining
trend during January 2008 (Figure 15). The January outcome was the lowest since July
2003 and was caused by a record fall of 8,3 points in the index of services production,
which more than offset a surprise increase in the index of manufacturing output. The yearon-year rate of change in the Organisation for Economic Co-operation and Development
(OECD) amplitude-adjusted composite leading indicator was a negative 2,4 per cent in
January 2008 after declining 2,1 per cent in the previous month, suggesting a slowdown
in economic activity in the major OECD economies. January data for individual countries
also suggest a slowdown in economic activity in the US, Japan, the euro area, Canada
and the UK. January 2008 data for non-OECD countries point to a possible downturn in
China and India, while continued expansions are expected in Russia and Brazil. The yearon-year rate of change in the OECD industrial production index increased slightly from
2,7 per cent in November 2007 to 3,0 per cent in January 2008.
Overall, the balance of risks to the global outlook is tilted to the downside, mainly due to
the continued turmoil in financial markets that could further reduce domestic demand in
advanced economies. Not only could ongoing financial market turbulence further reduce
domestic demand in advanced economies, but it could also spill over into emergingmarket and developing economies. Although banks have already taken most of the
writedowns needed on US sub-prime loans, the IMF has warned that as the US
economy weakens, the deterioration in credit will move up and across the credit
spectrum leading to slowing credit growth. The IMF expects Europe to also experience
South African Reserve Bank

Monetary Policy Review May 2008
Percentage change over twelve months
Index points


OECD amplitude adjusted CLI

OECD industrial production index

JPMorgan global manufacturing PMI (right-hand scale)
Sources: OECD and JPMorgan
Figure 15 OECD composite leading indicators

tightening conditions and slowing credit growth as its banks have experienced losses
and securitisation markets have contracted. Emerging markets are projected to show
continued resilience in the credit crisis although several countries that rely on
international markets and international bank borrowing to fund sizeable current-account
deficits and rapid credit growth will be at greater risk of economic contraction.
A number of factors continue to place upward pressure on oil prices, with little relief
expected until later this year. Oil demand continues to grow apace in China, India and
Russia, where fuel prices are heavily subsidised. In the Middle East, soaring energy
needs and shortfalls in natural gas supplies mean major exporters such as Saudi Arabia
and the United Arab Emirates must use more oil in their own region. The US Energy
Information Administration (EIA) predicts that even with falling consumption being
projected in the US, oil demand worldwide will jump by 1,2 million barrels a day this year.
The fact that the oil market currently has little spare capacity to tap in a crisis (i.e. the
fact that the 13-member OPEC now has just over two million barrels a day in excess
production capacity, almost all of it in Saudi Arabia) has also attracted greater
speculative interest in the market. Futures prices as at 5 May 2008 project Brent crude
oil prices of around US$114 per barrel for delivery in the third quarter of 2008.
Monetary Policy Review May 2008
South African Reserve Bank
Box 4 The impact of a US slowdown on the global economy
The US Conference Board’s leading business cycle indicator decreased sharply in November 2007
– its second consecutive monthly decline – having been down in four of the previous six months.
The leading composite index fell by 1,2 per cent from May to November 2007, the largest sixmonth decrease in the index in six years (a three-month decline in the leading index is deemed by
some observers to signal a recession but few economists actually use such a simple and inflexible
rule). Meanwhile, industrial production and real personal income less transfer payments peaked in
September 2007, real manufacturing and trade sales peaked in October, and, most recently,
employment peaked in December. After five years of strong global economic growth, an
increasingly important question for policy-makers in many countries is how hard the landing of the
US economy will be and how this will impact on the global economic growth outlook.
In 2007 there were expectations that strong sources of growth outside the US would prove resilient
to a consumer-led US recession. Decoupling, the notion that the rest of the world can weather the
effects of a slowing US economy, was expected by some analysts to ensure sustained global growth
in 2008 and beyond in the event of a US recession. Decoupling proponents backed their claims with
data available during 2007 that showed sustained strong growth in the economies of important US
trading partners. However, what had begun in 2006 as the cooling of the US housing market and
turned at the beginning of 2007 into a US sub-prime mortgage dilemma had expanded by the middle
of 2007 into a more severe reduction in the availability of credit. The financial turmoil then began
moving from the US to Europe, in part because of European banks’ exposure to the US mortgage
sector and in part because of corrections in real-estate markets, most notably in the United Kingdom
(UK) and Spain. As both banks and private households in affected countries had to write off nonperforming assets, the outlook for investment and consumption in these countries darkened
somewhat in the latter part of 2007. Towards the end of January 2008, another round of broad-based
turmoil in credit markets commenced. However, in contrast to the bank liquidity problems
experienced in 2007, the most recent problems were related to solvency at leveraged institutions that
had used borrowed money to purchase assets that had subsequently fallen in value. Banks became
increasingly concerned about their solvency and called in part of their loans. This resulted in leveraged
institutions in a number of countries being forced to sell assets in a falling market. It was becoming
increasingly apparent that powerful forces of globalisation could make substantial decoupling unlikely
and international financial institutions began to revise their global growth forecasts downwards.
However, the fallout from slowing growth in the US thus far has been limited as global growth
recorded in 2007 rounded off the best global four-year period in more than 30 years. Even the
International Monetary Fund’s latest estimate projects global growth of 3,7 per cent in 2008.
By lowering their policy rates, policy-makers in the US and the UK have striven to widen the gap
between short-term and long-term rates. Such a steeper yield curve should allow banks to restore
profitability by increasing the margin between their interest income from longer-term lending and
Outlook for domestic demand and supply
Domestic growth is set to moderate during 2008 on the back of weakened consumer
and business confidence, as well as capacity and skills constraints in certain sectors.
The impact of electricity supply constraints is particularly important in this regard.
Measures of domestic trade and manufacturing activity have decelerated further
although fixed investment has shown renewed resilience.
In its February 2008 Budget Review, the National Treasury expects economic growth to
slow to 4,0 per cent in 2008 before increasing to 4,2 per cent in 2009. Economic growth
is projected to increase to 4,6 per cent in 2010, partly in response to stimulus from the
2010 FIFA World Cup. According to the latest Reuters consensus forecasts surveyed in
March 2008, the South African economy is expected to grow by 3,7 per cent in 2008,
4,2 per cent in 2009 and 4,9 per cent in 2010. These forecasts represent the mean of
22 individual forecasts for 2008 and 2009 and the mean of 16 forecasts for 2010. They
range from 1,8 to 4,4 per cent for 2008, from 1,8 to 5,3 per cent for 2009, and from
3,9 to 5,5 per cent for 2010.
Consumer confidence, measured by the First National Bank/Bureau for Economic
Research (FNB/BER) Consumer Confidence Index (CCI) as the percentage of
South African Reserve Bank

Monetary Policy Review May 2008
their own costs from short-term borrowing. This should ensure that credit remains available to the
rest of the economy at lower costs, and complementary measures such as the recent concerted
liquidity management by the US and European central banks as well as help for troubled bond
insurers can foster the proper functioning of the financial system by facilitating balance-sheet
adjustments in the banking and private household sectors. If aggressively looser monetary policy
and the monetary transmission mechanism do not succeed in bringing about a steeper yield curve,
the feedback from the financial market turmoil to the real economy could be substantial. The credit
squeeze will have a stronger negative real economy impulse if tighter liquidity conditions, lower asset
values, impaired capital resources, reduced capital supply and slower aggregate demand feed back
on each other. A longer and deeper recession could then ensue as more expensive and rationed
mortgages result in house prices in the US and other industrial countries falling further and for longer.
Decoupling proponents point out that global economic growth has increasingly been driven by
emerging markets and developing countries in recent years. These economies have largely
abstained from excessive credit extension and are less exposed to present international financial
turmoil than some of the industrial countries. According to World Bank estimates, emerging-market
and developing countries contributed almost 70 per cent to global economic growth in 2007.
China added more than twice as much to growth as the US, while India accounted for as much as
the euro area. The world economy’s boom in the past five years has reflected a fundamental shift
in the prime drivers of growth. Even if the US and some other industrial countries were to suffer a
mild recession, output in emerging-market and developing countries could still keep global growth
substantially above 2 per cent – the rate that was seen to divide global expansions from recessions
in the past. However, in the event of a more prolonged US recession, European and Asian banks
would become less immune to the US credit squeeze if the market value of higher-quality US
mortgage debt to which these banks are exposed continues to fall. There are still no signs of
significant spillover from the US to China, India and key emerging-market countries. Countries with
current-account surpluses, well-capitalised banking systems and commodity exports should
continue to perform well, and this could generate a degree of reverse coupling, thereby dampening
a US slowdown.
References
World Bank. 2008. “Technology diffusion in the developing world”. Global Economic Prospects,
January.
Greenlaw, D., Hatzius, J., Kashyap, A. and Hyun Song, S. 2008. “Leveraged losses: lessons from
the mortgage market meltdown”. US Monetary Policy Forum Conference Draft, February.

respondents expecting an improvement in conditions less the percentage expecting
deterioration, declined from +22 in the final quarter of 2007 to a four-year low of +12 in
the first quarter of 2008. The previous occasion consumer confidence fell by such a big
margin was during the third quarter of 2004 when the index declined by 14 index points.
Although the CCI is currently at its lowest level in four years and although overall
consumer confidence has declined sharply during the first quarter of 2008, it
nevertheless remains relatively high as a reading of +12 indicates that the majority of
consumers is still optimistic about the future. The sharp decline in the first quarter was
mainly the result of a number of adverse developments since the previous survey, such
as rising capacity constraints.
The level of business confidence, measured in terms of the Rand Merchant Bank
(RMB)/BER Business Confidence Index, declined to its lowest level in six years (Figure 16).
The index measures business confidence on a scale of 0 to 100, with 0 indicating an
extreme lack of confidence, 50 neutrality and 100 extreme confidence. It declined from 67
in the fourth quarter of 2007 to 48 in the first quarter of 2008, with all subcomponents
declining in the quarter. The largest declines occurred among wholesalers and
manufacturers, declining by 35 and 23 index points, respectively, with new vehicle dealers’
confidence declining by a further 4 index points to a level of 30. Building contractors’
confidence declined from 83 to a level of 69 and retailers’ confidence declined by 19 index
points to a level of 52 in the first quarter of 2008. The net negative sentiment that prevailed
can be attributed to a contraction in business volumes, reduced profitability, declining
household spending as well as electricity supply disruptions. The fieldwork for the firstquarter survey took place between 4 February and 4 March 2008.
The South African Chamber of Commerce and Industry’s Trade Activity Index, which is a
composite index of sales volumes, new orders, supplier deliveries, inventory levels and
employment, rose by 2 index points from 48 in January to 50 in February 2008. However,
the index is still 8 index points lower than the level of 58 reported in March 2007. The latest
survey results point towards a possible bottoming of trade conditions that had slowed
substantially towards the end of last year. The Trade Expectations Index, which has
remained in the 66 – 68 range since March 2007, was at 67 index points in February 2008.
Monetary Policy Review May 2008
South African Reserve Bank
Percentage
1980 82

98 2000

Downward phases of business cycle
Sources: Rand Merchant Bank and Bureau for Economic Research
Figure 16 RMB/BER Business Confidence Index
Net positive
Net negative
The Investec/BER PMI, a barometer of manufacturing activity, increased to 54,1 in April
2008, after dropping to 43,7 in March. The timing of Easter during 2008 would have
artificially depressed the March reading and probably explains the concomitant sharp
increase in April. Business activity and new sales orders were somewhat firmer in April,
and a more appropriate average March and April reading, while still showing a slight
improvement on February, remains under the critical level of 50 indicating continued
pressure on the sector. The combined March and April employment number of 48,1 also
showed a slight improvement on February, but at a level below 50 is consistent with a
moderate decline in employment. Pressure on input prices continued to mount, with the
PMI input price sub-index increasing from 90,7 in March to 93,1 in April 2008.
Confidence levels in the civil construction industry, which provide an insight into trends in
fixed investment, declined slightly in the first quarter of 2008, despite the continued robust
performance of fixed investment growth in the economy. The FNB Civil Construction
Confidence Index, which reflects the proportion of managers expressing satisfaction with
current conditions in the industry, decreased from an index value of 83 in the fourth quarter
of 2007 to 79 in the first quarter of 2008. Tendering competition increased during the first
quarter of 2008, reflecting the moderation in the current level of construction activity
reported by respondents to the survey. Notwithstanding the rise in tendering competition,
margins of respondents and therefore the growth in the profitability of companies
responding to the survey was not unduly impeded. However, expectations are that
business conditions in the civil construction sector are unlikely to deteriorate further.
Indicators of inflation expectations
Inflation expectations have increased significantly in recent months. A survey of inflation
expectations, undertaken by the BER in the first quarter of 2008, reports that inflation
expectations registered the largest increase between consecutive quarters in the
survey’s eight-year history (Figure 17).
South African Reserve Bank

Monetary Policy Review May 2008
Annual averages, per cent

Figure 17
BER surveys of CPIX inflation expectations

Survey conducted during:

07Q2

07Q3

07Q4

08Q1
Source: Bureau for Economic Research, University of Stellenbosch

According to the first quarter of 2008 survey, CPIX inflation is expected to average
7,8 per cent in 2008, before declining to 7,0 per cent in 2009 and 6,7 per cent in
2010. As Figure 17 shows, these results are notably higher than those obtained in
the previous three surveys. Disaggregated according to different survey groups as
shown in Table 9, business people and trade union leaders expect CPIX to remain at
around 7,5 per cent over the forecast period. However, financial analysts expect
CPIX inflation to decline from 8,1 per cent in 2008 to 5,9 per cent in 2009 and
5,4 per cent in 2010.
Table 9
BER survey of CPIX inflation expectations: First quarter 2008*
Per cent


Fourth-quarter 2007 results in parentheses
Source: Bureau for Economic Research, University of Stellenbosch
Deteriorating inflation expectations are also evident from the March 2008 Reuters survey
of long-term forecasts for the South African economy (Table 10). According to this
survey, the mean CPIX inflation rate is expected to reach 8,8 per cent in 2008, before
slowing to 6,0 per cent in 2009 and 5,4 per cent in 2010. Consistent with the BER
survey, the March 2008 Reuters forecasts represent a significant upward revision to the
results of the February survey.
Table 10
Reuters survey of CPIX forecasts: March 2008*
Per cent


February 2008 survey results in parentheses
Source: Reuters
Expectations derived from break-even inflation rates, measured as the difference
between the yields on South African CPI inflation-linked bonds and conventional
nominal bonds of similar maturity, also suggest that inflation expectations have moved
higher in the period under review (Figure 18). Break-even inflation rates obtained from
the R197 (maturing 2023) inflation-linked bond rose from 4,94 per cent at the beginning
of November 2007 to 6,59 per cent on 29 April 2008, while those from the
R189 (maturing 2013) inflation-linked bond increased from 5,64 per cent to 7,63 per
cent over the same period.
Monetary Policy Review May 2008
South African Reserve Bank
The South African Reserve Bank inflation forecast
The most recent projections of the Bank’s quarterly inflation-forecasting model,
presented to the MPC meeting on 9 and 10 April 2008, are reproduced in the form of a
fan chart in Figure 19. According to these projections, the inflation outlook has
deteriorated since the publication of the previous Monetary Policy Review in November
2007. This deterioration is ascribed to recent inflation outcomes being higher than
South African Reserve Bank

Monetary Policy Review May 2008
Percentage points

Figure 18 Break-even inflation rates

Spread between R189 and R153 bonds

Spread between R197 and R186 bonds

Per cent

Figure 19 CPIX forecast

Note:
The fan chart uses confidence bands to depict varying degrees of
certainty. The darkest band of the fan chart covers the most likely 10 per
cent of probable outcomes foreseen for CPIX inflation, including the
central projection. Each successive band, shaded slightly lighter and
added on either side of the central band, adds a further 10 per cent to
the probability until the whole shaded area depicts a 90-per-cent
confidence interval (see Box 4 “Understanding the fan chart” on p. 27 of
the March 2001 Monetary Policy Review).

expected, and to further upward revisions to the oil and administered prices assumptions
for 2008 and 2009. The administered prices assumption makes provision for the National
Energy Regulator of South Africa’s (NERSA) approved 14,2 per cent electricity price
increase as well as the 2c/kWh electricity levy announced in the Budget Speech of
February 2008. The central projection, conditional on an unchanged repurchase rate, is
for the average CPIX inflation rate to peak at 9,3 per cent in the first quarter of 2008, and
then decline to within the inflation target range in the final quarter of 2009.
A number of factors currently pose risks to the inflation outlook. The possibility of further
electricity price increases appears the most significant and immediate upside risk.
Eskom has applied for a revision of the increase for 2008/09 from 14,2 per cent to
60 per cent, and for a further increase of a similar magnitude in the following year.
International oil prices also continue to pose a threat in this regard despite the slowdown
in global economic growth, and food prices show few signs of moderating
internationally. The threat from oil and food price developments is itself partly dependent
on developments in the rand exchange rate. Increased risk aversion in global markets
and negative perceptions regarding the size of the current-account deficit are factors
that increase the risk to the inflation outlook arising from the exchange rate.
Balancing these upside risks are factors that are expected to have a moderating effect
on the inflation outlook. Slower growth in overall economic activity, reflected particularly
in household consumption expenditure and in bank credit extension to the private
sector, is an important factor in this regard. Asset prices are also providing less
encouragement for inflation, with house-price increases moderating in recent months.
Assessment and conclusion
The monetary policy environment remains particularly challenging. While South Africa
has unique challenges, other inflation-targeting countries are also having to deal with
similar significant food and oil-price shocks. Indications are currently that food price
increases are becoming more entrenched globally, and are being compounded by the
restriction of food exports by a number of countries. The situation is further aggravated
by the diversion of food production to biofuels in response to high and rising
international energy prices. Unusually, despite the economic slowdown in the US,
commodity prices in general have not only remained strong but have risen, adding to the
challenges faced by monetary policy. International financial market volatility and
uncertainty have not subsided, and against this background, many inflation-targeting
countries have found it increasingly difficult to remain within their target ranges. The
challenge for these countries, including South Africa, is to ensure that inflation returns to
within the inflation target range within a reasonable period of time.
Domestically, the possibility of further electricity price increases poses an additional risk
to the inflation outlook. At the same time, the economy has been responding to the
previous monetary policy actions taken by the MPC, and household consumption
expenditure is moderating. However, inflation expectations have increased and are no
longer clearly anchored within the inflation target range over time.
Monetary policy will continue to focus on the medium-term outcomes because of the
lagged response to monetary policy actions. The Bank’s current expectation is for
inflation to peak in the near term and then to follow a downward trend to return to within
the target range by the end of 2009. There are, however, a number of upside risks to
this outlook, and the MPC remains committed to bringing inflation back to within the
target range over a reasonable time horizon.
Monetary Policy Review May 2008
South African Reserve Bank
Statements issued by
Mr T T Mboweni,
Governor of the South African Reserve Bank
Statement of the Monetary Policy Committee
6 December 2007
Issued by Mr T T Mboweni, Governor of the South African Reserve Bank, at a meeting
of the Monetary Policy Committee (MPC) in Pretoria
Introduction
The short-term inflation outlook has deteriorated since the previous meeting of the Monetary
Policy Committee (MPC). Food and energy prices have maintained pressure on inflation and
these pressures are expected to persist in the coming months. At the same time, previous
monetary policy actions are probably beginning to have an impact on household
consumption expenditure and this is expected to help moderate inflation pressures over
time. The MPC, however, has to ensure that the short-term impact of higher inflation does
not allow inflation expectations to become entrenched at higher levels.
Recent developments in inflation
CPIX inflation remained outside the target range for the seventh consecutive month,
reaching a four-and-a-half-year high of 7,3 per cent in October 2007. Food price inflation
has continued to accelerate, measuring 12,4 per cent in October. Most of the food
categories in CPIX recorded double-digit rates of increase, with the main contributions
emanating from grain products, milk, cheese and eggs, and vegetables. Meat price
inflation, however, declined to 6,6 per cent. Petrol prices increased at a year-on-year
rate of 12,0 per cent in October following moderate increases in the previous three
months. Administered prices excluding petrol continued their upward trend and
measured 8,5 per cent in October.
There is, however, some evidence that upward pressure on other components of
inflation may be moderating. If food and petrol were excluded, CPIX inflation would have
measured 4,8 per cent in October, compared to 5,0 per cent in July and August 2007.
Low or negative rates of inflation are still being recorded in the following categories:
clothing and footwear, furniture, recreation, and communication.
Production price inflation in October 2007 remained high at 9,5 per cent, which was
marginally above that in the previous two months. Imported goods inflation declined
to 7,5 per cent, while the prices of domestically produced goods increased by 10,2 per
cent. Prices of agricultural and manufactured foods increased by 26,1 per cent and
17,5 per cent, respectively, which suggests that further pressures on retail food prices
can be expected in the coming months.
The outlook for inflation
The most recent central forecast of the Bank indicates a further deterioration in the
inflation outlook, particularly in the short term, when compared to the previous
forecast. CPIX inflation is now expected to peak at around 7,8 per cent in the first
quarter of next year. Thereafter, CPIX inflation is expected to decline to below the upper
end of the target range by the final quarter of 2008. A gradual downward trend is
expected to persist and to measure 5,2 per cent in the final quarter of 2009. The higher
trend is a result of higher administered price assumptions, particularly for petrol and
electricity, over the forecast period.
South African Reserve Bank

Monetary Policy Review May 2008

Despite the higher short-term trend in inflation, expectations remain contained within the
inflation target range. According to the inflation expectations survey that is conducted
on behalf of the Bank by the Bureau for Economic Research (BER) at the University of
Stellenbosch, there was only a slight deterioration in expectations in the fourth quarter
compared to those in the third quarter when a significant increase in expectations was
recorded. CPIX inflation in 2008 is now expected to average 5,9 per cent, compared to
the 5,8 per cent expected in the previous survey. Significantly, CPIX inflation
expectations for 2009 remained unchanged at 5,6 per cent.
Expectations as reflected in the break-even inflation rates, which is the yield differential
between conventional and inflation-linked bonds, reflect some deterioration. Break-even
inflation rates over different maturities decreased between the August and October
meetings of the MPC. Since the October meeting, break-even inflation has increased
somewhat over all maturities, but still remains below the 6 per cent level.
The main risks to the inflation outlook emanate from food, petrol and electricity price
prospects. International oil prices have continued to remain an upside risk factor. At the
time of the October meeting of the MPC, North Sea Brent crude oil prices were trading
at around US$78 per barrel. Since then, prices have increased to peak at almost
US$100 per barrel, although in recent days prices have declined to around US$90 per
barrel. Domestic petrol prices have been adversely affected by these international
trends, and the local price of 93 octane petrol increased by 3 cents per litre in November
2007 and by 43 cents per litre in December.
The degree of upside risk from food price increases may have subsided over time, but food
prices nevertheless remain the main contributors to inflation. As noted, production prices
indicate that further pressures can be expected on CPIX in the short term. However there
are expectations of some moderation during the course of next year as a result of base
effects, more favourable weather conditions and higher crop estimates. Futures prices
generally reflect an expectation of lower prices, particularly for maize, during 2008. Global
food price pressures are nevertheless expected to persist for some time.
Electricity prices in particular pose a significant risk to the inflation outlook. The National
Energy Regulator of South Africa is due to make a decision on the application by Eskom
to raise electricity tariffs by 18 per cent in 2008 and 17 per cent in 2009 in order to help
finance its capital expenditure programme.
Despite these risks and pressures, not all the recent developments have been
negative from an inflation perspective. In particular, there is evidence of a lagged
response by the economy to the previous monetary policy tightening. Household
consumption expenditure continues to show some signs of moderation in response
to the changed monetary policy stance and lower household disposable income
growth. Final consumption expenditure by households grew by 4,5 per cent in the
third quarter of 2007, compared to a revised 4,9 per cent growth in the second
quarter. This third quarter moderation was a result of a marked deceleration in real
expenditure on semi-durable goods in particular. The real value of retail sales
remained broadly unchanged from the second quarter to the third quarter. Sales of
new vehicles also remained subdued. Despite these developments, the FNB/BER
Consumer Confidence Index reflected an increase in consumer confidence during
the fourth quarter.
Reflecting the slowdown in household consumption expenditure, credit extension to the
private sector has shown some signs of moderation, but nevertheless remains at high
Monetary Policy Review May 2008
South African Reserve Bank
levels. Twelve-month growth in total loans and advances had declined gradually over the
past few months. Growth over 12 months in loans and advances extended to the
household sector declined to 20,1 per cent in October 2007, having peaked at 28,2 per
cent in February 2006. The growth rate of loans and advances to the corporate sector
declined to 29,7 per cent in October. Household debt as a percentage of household
disposable income increased to 77,4 per cent in the third quarter.
Asset price growth, which in the past has helped to underpin domestic demand,
appears to be somewhat restrained. Having recovered from the initial impact of the
subprime developments in the United States (US) and euro area, the JSE Limited has
been fairly volatile, in line with the uncertainties that prevailed in the global equity
markets. In addition, according to Absa Bank, the year-on-year rate of increase in house
prices in the middle segment has declined further to 13,6 per cent in October.
Fiscal policy continues to be supportive of monetary policy. In the October Medium Term
Budget Policy Statement, the commitment to fiscal prudence was confirmed with the
projection of fiscal surpluses for the coming three years.
Output growth remained strong, with gross domestic product (GDP) growth measuring
4,7 per cent in the third quarter of 2007 compared to a revised 4,4 per cent in the second
quarter. Economic growth therefore continues to be at around rates consistent with the
potential growth rate of the economy. Growth in gross fixed capital formation remained
strong in the third quarter, and this is expected to underpin growth going forward.
The exchange rate of the rand has displayed a higher degree of volatility in recent weeks,
but nevertheless has remained relatively unchanged since the previous meeting of the
MPC. The relative strength of the rand has been underpinned by sustained capital
inflows which financed an expanding current-account deficit in the third quarter of 2007.
The deficit, which measured approximately 8,1 per cent of GDP, was driven mainly by
increased imports of manufactured goods, as well as by a marked acceleration in
service payments to non-residents. Despite this, capital inflows were sufficient to allow
for a further accumulation of foreign-exchange reserves by the Bank. At the end of
November, the official gross gold and other foreign-exchange reserves had increased to
US$32,3 billion, and the international liquidity position to US$30,7 billion.
The outlook for the international economy remains uncertain, with continued turbulence
in international financial markets. The reported losses of institutions with exposure to the
US sub-prime mortgage market have exceeded expectations and there are concerns
that the downturn in some of the advanced economies may be more severe than
originally anticipated. Global inflation appears to be contained although oil and food
prices continue to pose a risk to the outlook.
Monetary policy stance
The assessment of the MPC is that the balance of risks to the inflation outlook continues
to be on the upside. Therefore, the MPC has decided to adjust the repurchase rate by
50 basis points to 11,0 per cent per annum with effect from Friday, 7 December 2007.
The MPC will continue to monitor relevant developments and take the necessary steps
to ensure that inflation returns to within the target range.
South African Reserve Bank

Monetary Policy Review May 2008

Statement of the Monetary Policy Committee
31 January 2008
Issued by Mr T T Mboweni, Governor of the South African Reserve Bank, at a meeting
of the Monetary Policy Committee in Pretoria
Introduction
Since the previous meeting of the Monetary Policy Committee (MPC) in December 2007,
the international environment has become increasingly uncertain and volatile. It appears
that the continued fall-out from the United States (US) sub-prime crisis has not been
confined to financial markets only and there has been a general downward revision to
forecasts of global growth.
The slowdown in global growth could have spill-over effects on the South African
economy which is also being affected adversely by electricity supply constraints. The
economy has continued to respond to the tighter monetary policy stance and inflation
is expected to peak in the first quarter of 2008. Nevertheless, there are still significant
risks to the inflation outlook.
Recent developments in inflation
CPIX inflation has continued its upward trend, measuring 8,6 per cent in December
2007. The main drivers were again petrol and food. Petrol prices increased at a year-onyear rate of 23,8 per cent in December, while food prices increased at a rate of 13,9 per
cent. Excluding food and petrol, CPIX inflation would have measured 5,0 per cent.
Prices of clothing and footwear declined significantly, while modest declines were
measured in recreation and entertainment, and textiles.
Production price inflation measured 10,3 per cent in December compared to 9,1 per
cent in November. Prices of imported goods increased at a year-on-year rate of 11,3 per
cent compared to 7,3 per cent the previous month. Manufactured food inflation
increased to 18,7 per cent from 18,3 per cent in November while agricultural products
inflation declined to 24,0 per cent from 26,8 per cent.
The outlook for inflation
The most recent central forecast of the Bank indicates a further deterioration in the
inflation outlook in the short term when compared to the previous forecast. CPIX inflation
is still expected to peak in the first quarter of 2008, but at an average of around 8,5 per
cent. In line with the previous forecast, CPIX inflation is then expected to decline to
below the upper end of the target range by the final quarter of 2008 and to remain at
around the 5,6-per-cent level for most of 2009. The higher near-term projections are a
result of slightly higher inflation outcomes and further revisions to assumptions about
administered prices.
This central forecast of the Bank is broadly consistent with market expectations. The
Reuters consensus forecast also expects inflation to peak during the first quarter of
2008 and to fall below the upper level of the target range in the fourth quarter. CPIX
inflation is expected to average 6,8 per cent and 5,3 per cent in 2008 and 2009,
respectively. The longer-term inflation expectations, as reflected in the break-even
inflation rates, have remained relatively unchanged at below the 6-per-cent level since
the previous MPC meeting.
Monetary Policy Review May 2008
South African Reserve Bank
The main upside risks to the inflation outlook remain food and energy price prospects,
although the extent of the upside risk may have moderated somewhat. The price of
North Sea Brent crude oil, which peaked at around US$100 per barrel in December, is
currently trading at around US$92 per barrel. Domestic petrol prices remained
unchanged in January and the current average under-recovery for January is
approximately 15 cents per litre. Oil prices remain vulnerable to supply disruptions,
although the adverse global growth outlook may restrain the degree of upside price risk.
Food prices remain one of the main short-term risks to inflation. Production prices
continue to indicate that sustained food price pressure can be expected in the coming
months. However, the more favourable weather conditions and lower futures prices for
maize have reinforced a general expectation of some moderation of food price inflation
during the course of this year. However, future trends will be dominated by global supply
and demand conditions.
The threat posed to the inflation outlook by higher electricity prices remains. Eskom has
been granted an average tariff increase of 14,2 per cent from July. The precise increase
that will be faced by households may be higher and will only be known during the
coming months. Furthermore, there is a risk that the increases granted to Eskom over
the forecast period could be higher than currently anticipated.
The rand exchange rate has depreciated in recent weeks following a period of relative
stability. The currency has been affected by movements in the dollar and, more recently,
by increased risk aversion towards emerging markets. The currency has been given
some support from commodity prices, which have remained firm, and in the case of gold
and platinum, have reached new highs. On a trade-weighted basis, the rand has
depreciated by around 7 per cent since the beginning of 2008.
Despite these pressures and risks to the outlook, there have been a number of
developments that are likely to have a restraining impact on the inflation trend. The
moderation of household consumption expenditure highlighted at the previous meeting
appears to have continued. Real retail sales have trended downwards since the middle
of 2007 and in November sales decreased by 0,7 per cent compared to October. Sales
of household furniture, appliances and equipment have contracted the most. Motor
vehicle sales also continued their downward trend. Sales of passenger vehicles declined
by almost 10 per cent in 2007 compared to 2006, although commercial vehicle sales
remained relatively strong.
Growth in household consumption expenditure is also expected to be dampened by
negative wealth effects. The global financial market turbulence has been reflected in the
volatility on the JSE Limited. Since its peak in October 2007, the all-share index has
fallen by approximately 16 per cent. House price increases have also moderated
somewhat. According to the Absa House Price Index, house price increases declined to
11,2 per cent in December 2007, while the month-on-month increase in December was
0,3 per cent. The Standard Bank House Price Index was unchanged on a year-on-year
basis in December.
Credit extension to the private sector has moderated further. Growth over 12 months in
loans and advances extended to the private sector declined from 25,2 per cent
in September 2007 to 22,2 per cent in December. The quarterly growth declined from
23,5 per cent in the third quarter to 18,1 per cent in the fourth quarter. Growth in all the
subcategories, namely mortgage advances, instalment sales and leasing, and other
loans and advances, has displayed a persistent downward trend. The growth in
South African Reserve Bank

Monetary Policy Review May 2008

loans and advances to households declined to 18,9 per cent in December 2007, down
from 20,1 per cent in November.
According to the Wage Settlement Survey by Andrew Levy Employment Publications,
the average wage settlement for 2007 was 7,3 per cent compared to 6,5 per cent in
2006. This appears to be consistent with the 7,7 per cent year-on-year increase in
average nominal remuneration per worker measured in the third quarter of 2007. Once
productivity increases are adjusted for, year-on-year growth in nominal unit labour costs
in the formal non-agricultural sector measured 4,8 per cent in the third quarter of 2007,
compared to 5,0 per cent the previous quarter. These unit labour cost developments are
consistent with the inflation target range.
The risks to output growth appear to be on the downside and this is likely to be
reinforced by the electricity supply disruptions. Growth in the construction sector also
appears to be moderating with a decline in residential and non-residential plans
approved. In November 2007 the real value of building plans passed decreased by
16,5 per cent on a year-on-year basis. The volume of cement sales has also shown a
significant decline in recent months.
The turbulence in international financial markets has not subsided and losses suffered
by financial institutions with exposure to the US sub-prime market continue to be
reported. Fears of a slowdown in some of the advanced economies, and in the US in
particular, have also been weighing on the markets. Although the emerging-market
economies are expected to sustain relatively strong growth, there are indications of
some moderation in growth in China, albeit still at high levels. Global inflation appears to
be under control.
Monetary policy stance
There are still considerable risks to the inflation outlook. In the light of, inter alia,
heightened economic uncertainties, both domestically and globally, and some evidence
of moderation in domestic consumption expenditure, the MPC has decided that it is
appropriate at this time to leave the repo rate unchanged at 11 per cent per annum. The
MPC remains committed to bringing inflation back to within the inflation target range.
Monetary Policy Review May 2008
South African Reserve Bank
Statement of the Monetary Policy Committee
10 April 2008
Issued by Mr T T Mboweni, Governor of the South African Reserve Bank, at a meeting
of the Monetary Policy Committee in Pretoria
Introduction
The South African economy continues to respond to the less accommodative monetary
policy stance. Domestic expenditure is responding to the Bank’s current policy settings.
Various high-frequency and survey data point to the economy growing at a rate below
potential, but nevertheless underpinned to some extent by strong investment
expenditure by the private sector and public corporations.
The inflation outlook is being influenced by a series of supply-side shocks emanating
from the international oil and food prices, which are posing challenges for inflationtargeting countries in general. Domestically, there is evidence of generalised price
pressures and the prospect of further substantial electricity price increases will also delay
the return to within the inflation target range. In the light of these developments, inflation
expectations have deteriorated.
Recent developments in inflation
CPIX inflation has maintained its upward trend, reaching 9,4 per cent in February 2008.
Petrol and food prices were again the main drivers of inflation and increased at year-onyear rates of 29,5 per cent and 14,3 per cent, respectively. If food and energy prices
were excluded, CPIX inflation would have measured 5,6 per cent. Further impetus to
inflation came from the change in methodology for calculating clothing and footwear
prices. Whereas clothing and footwear prices were previously shown to have declined
persistently since October 2003, these prices increased at year-on-year rates of 7,9 per
cent and 8,4 per cent in January and February 2008, respectively.
Year-on-year producer price inflation measured 11,3 per cent in February compared to
10,4 per cent in January. Agricultural food prices increased at a year-on-year rate of
23,5 per cent in February, while manufactured food prices increased by 20,9 per cent.
The outlook for inflation
The most recent central forecast of the Bank indicates a further deterioration in the
inflation outlook when compared to the previous forecast. Inflation is now expected to
peak at an average of around 9,3 per cent in the first quarter of this year, and thereafter
to follow a downward trajectory. However, CPIX inflation is now expected to return to
within the inflation target range by the fourth quarter of 2009. The deterioration in the
outlook is a result of higher-than-expected recent quarterly inflation outcomes, and
further upward revisions of oil and administered price assumptions for 2008 and 2009.
The possibility of an electricity price increase in excess of that recently granted to Eskom
has not been factored into the central forecast, although the Monetary Policy Committee
(MPC) has considered various alternative scenarios.
Most private-sector forecasts have also been revised upwards in recent weeks, although
the majority predict inflation will return to within the target range before the final quarter of
next year. The Reuters consensus forecast also expects inflation to peak in the first quarter
of this year, and to return to within the target range during the second quarter of 2009.
South African Reserve Bank

Monetary Policy Review May 2008

The current inflation trends are having a significant impact on inflation expectations,
particularly those of business executives and trade union officials. According to the inflation
expectations survey conducted on behalf of the Bank by the Bureau for Economic
Research (BER) at the University of Stellenbosch, average CPIX inflation expectations for
2008 have increased from 5,9 per cent at the time of the previous survey to 7,8 per cent,
and for 2009 from 5,6 per cent to 7,0 per cent. CPIX inflation is expected to average
6,7 per cent in 2010. Whereas financial analysts expect inflation to moderate to 5,9 per
cent in 2009 and 5,4 per cent in 2010, business executives and trade union officials expect
inflation to average 7,5 per cent and 7,4 per cent in those years respectively.
Break-even inflation rates, measured as the yield differential between conventional
government bonds and inflation-linked bonds, also indicate a deterioration of inflation
expectations.
The trend of wage settlements is a critical variable in determining whether inflation
expectations do, in fact, translate into higher inflation. There is evidence that nominal
wage settlements have been trending higher. According to Andrew Levy Employment
Publications, wage settlements in the first quarter of 2008 averaged 7,8 per cent
compared to 7,3 per cent in 2007 and 6,5 per cent in 2006.
A number of factors continue to pose an upside risk to the inflation outlook. The most
serious risk emanates from the possibility of additional electricity price increases. If
granted, the electricity price will have doubled by the middle of 2009. A final
determination will be made by the National Energy Regulator of South Africa in June.
International oil prices have remained at elevated levels. The price of North Sea Brent
crude oil was US$92 per barrel at the time of the previous MPC meeting and is currently
trading at around US$107 per barrel. The impact on CPIX has been aggravated by the
depreciation of the rand against the dollar, and in the past two months, the rand price
of 95 octane petrol has increased by a total of R1,27 per litre. Of this increase, 43 cents
was due to international product price increases and 69 cents was due to exchangerate changes. The remainder was accounted for by tax and other levy adjustments.
Despite the slowdown in the global economy, international oil price developments
continue to pose an upside risk to the inflation outlook.
Since the previous meeting of the MPC, the rand exchange rate has depreciated further.
On a trade-weighted basis, the rand has now depreciated by around 16 per cent since
the beginning of 2008. In March the rand depreciated to almost R8,26 against the US
dollar, but is currently trading at around R7,90. The currency has been affected by
various factors, including movements in the dollar, perceptions that the current-account
deficit on the balance of payments could widen and increased risk aversion in global
financial markets since the previous MPC meeting. Firm international commodity prices,
however, continue to provide some support to the currency.
Food price inflation has shown few signs of moderating and trends at the producer level
indicate further pipeline pressures. International food price developments are particularly
worrisome with a number of food-producing countries restricting exports in recent
weeks. International wheat prices have also reached new highs. Domestic spot prices
of maize have been volatile around an upward trend, partly as a result of the depreciated
exchange rate. Futures prices suggest that maize prices are expected to remain high in
the coming months despite the improved crop forecast for this year.
There are a number of factors that are expected to have a moderating effect on the
inflation outlook.
Monetary Policy Review May 2008
South African Reserve Bank
Household consumption expenditure has continued to respond to the tighter monetary
policy stance. Real final consumption expenditure growth declined consistently during
2007, and grew at an annualised rate of 3,8 per cent in the fourth quarter. This softer
trend appears to have continued in the first quarter of 2008 as evidenced by the negative
retail sales trends in the past few months. Motor vehicle sales have declined further, with
new passenger vehicle sales being particularly affected. When comparing the first three
months of 2008 with the same period last year, a decrease of 19,1 per cent was
recorded. The latest FNB/BER Consumer Confidence Index shows a distinct break with
recent trends. Although still at relatively high levels, the index declined to its lowest level
in 3,5 years in the first quarter of this year.
This slower household consumption expenditure growth is reflected to some extent in
the declining trend of bank credit extension to the private sector. Twelve-month growth
in banks’ total loans and advances extended to the private sector, which has exhibited
a downward trend, slowed to 21,8 per cent in February. Growth in all categories of credit
extension declined in February. The ratio of household debt to disposable income
increased marginally to 77,6 per cent in the fourth quarter of 2007. The cost of servicing
this debt has increased significantly, in line with higher interest rates.
The domestic economy has shown signs of moderation following a robust annual growth
rate of 5,1 per cent in 2007. A number of indicators suggest that output growth will be below
potential in the coming quarters, although infrastructural investment programmes are likely
to underpin the overall growth rate. At this stage it is still unclear what the impact of electricity
supply disruptions will be on output growth. The composite leading business cycle indicator
has been declining significantly since November 2007, while in the first quarter of this year
the RMB/BER Business Confidence Index declined to its lowest level in seven years. The
significant decline in the Investec/BER Purchasing Managers Index in March may be
pointing to a marked slowdown in the manufacturing sector, despite the improved
performance in February when real output increased at a month-on-month rate of 2,4 per
cent. Mining output declined by 5,2 per cent during the three months ended February 2008.
Asset prices have also been subdued since the previous meeting of the MPC. The Absa
House Price Index shows that year-on-year growth in prices of residential property in the
middle segment of the market declined to 8,7 per cent in February 2007, while the median
house price, as measured by Standard Bank, declined by 5,2 per cent in March. The allshare index on the JSE Limited has increased by about 15 per cent since the end of
January, driven primarily by the impact of strong commodity prices on the resources sector.
The international economic and financial environment remains uncertain and volatile. The
sustained weakness in the US housing market has resulted in downward revisions of US
growth forecasts, while the IMF has revised downwards its forecast for global growth in
2008 to 3,7 per cent, from 4,1 per cent forecast in January. Global inflation forecasts have
been revised upwards in the wake of higher food and energy prices. Nevertheless, global
inflation appears to be relatively contained. The turmoil in financial markets is expected to
persist for some time as banks keep writing down more financial assets and experience
losses. As a consequence, global foreign-exchange and financial markets are likely to
remain volatile.
Monetary policy stance
In view of the deteriorating inflation outlook, and especially evidence of more generalised
inflation pressures, the MPC has decided to increase the repo rate by 50 basis points to
11,5 per cent per annum with effect from 11 April 2008. The MPC remains committed
to bringing CPIX inflation back to within the inflation target range.
South African Reserve Bank

Monetary Policy Review May 2008

Abbreviations
Alsi
all-share index
API
administered price index
BER
Bureau for Economic Research (Stellenbosch University)
CCI
Consumer Confidence Index
CLI
composite leading indicator
CPI
consumer price index for metropolitan areas
CPIX
consumer price index excluding mortgage interest cost for metropolitan
and other urban areas
ECB
European Central Bank
EIA
Energy Information Administration
EU
European Union
FAO
Food and Agriculture Organization
FNB
First National Bank
GDP
gross domestic product
IFAD
International Fund for Agricultural Development
IMF
International Monetary Fund
IT
inflation targeting
JSE
JSE Limited
MPC
Monetary Policy Committee
NEER
nominal effective exchange rate of the rand
NERSA
National Energy Regulator of South Africa
OECD
Organisation for Economic Co-operation and Development
OPEC
Organization of the Petroleum Exporting Countries
PMI
Purchasing Managers Index
PPI
producer price index
PSBR
public-sector borrowing requirement
repo
repurchase
RMB
Rand Merchant Bank
SARB
South African Reserve Bank
SIC
Standard Industrial Classification
Stats SA
Statistics South Africa
UK
United Kingdom
US
United States
Monetary Policy Review May 2008
South African Reserve Bank