South African Reserve Bank
Press Statement
Embargo Delivery
21 July 2016

Statement of the Monetary Policy Committee

Issued by Lesetja Kganyago, Governor of the South African Reserve Bank
The UK vote to leave the European Union has dominated the global landscape in the
past month. The outlook for the global economy has become more uncertain as the
potential consequences of these developments are being assessed. The lack of
clarity regarding the process going forward has had significant implications for global
growth and interest rates as the prospects for further near-term monetary policy
tightening by the US Fed recede. While there have been spillovers to the South
African financial markets, particularly the exchange rate, the direct short-term impact
on South African growth and trade is likely to be fairly limited. Domestic growth has
surprised further on the downside, and the outlook remains constrained. At the same
time domestic inflation outcomes have surprised marginally on the downside, but an
extended breach of the target is still expected.
The year-on-year inflation rate as measured by the consumer price index (CPI) for all
urban areas moderated to 6,1 per cent in May, before rising to 6,3 per cent in June.
Food price inflation measured 11,0 per cent in June, below the recent peak of 11,3
per cent in April, and was marginally negative on a month-on-month basis. Goods

price inflation measured 6,7 per cent, up from 6,6 per cent in May, while services
increased by 5,8 per cent, up from 5,7 per cent in May. The Bank’s measure of core
inflation, which excludes food, fuel and electricity measured 5,6 per cent, up from 5,5
per cent previously.
Producer price inflation for final manufactured goods continued its downward trend,
declining from 7,0 per cent in April to 6,5 per cent in May mainly due to a further
moderation in price inflation of food, beverages and tobacco products. This was
below the consensus forecast of 6,9 per cent. The impact of the drought is still
evident in the increase in prices of agricultural products, particularly cereals and
other crops as well as live animals and animal products.
The latest inflation forecast of the Bank shows a marginal improvement compared
with the previous forecast. Nevertheless, inflation is still expected to accelerate
further this year and is only expected to return to within the target range of 3-6 per
cent during the third quarter of 2017. Inflation is now expected to average 6,6 per
cent in 2016 and 6,0 per cent in 2017, compared with 6,7 per cent and 6,2 per cent
previously. In 2018 inflation is expected to average 5,5 per cent, marginally up from
the previous forecast. The expected peak, at 7,1 per cent in the fourth quarter of
2016, is down from 7,3 per cent. The downward revisions are due in part to lower
administered price inflation (mainly petrol), despite a small upward adjustment in the
international oil price assumption.
The forecast for core inflation is lower than the previous forecast in the near term,
mainly due to the lower starting point, but higher in the outer period. Core inflation is
expected to moderate from an average of 5,8 per cent in 2016 to 5,3 per cent by
2018. Whereas previously core inflation was expected to breach the upper end of the

target range in the third quarter of 2016 for four consecutive quarters, a one-quarter
breach, at 6,1 per cent, is now expected in the fourth quarter of this year.
Inflation expectations as reflected in the survey conducted by the Bureau for
Economic Research have remained relatively anchored at the upper end of the
inflation target range. In the second quarter, average expectations for 2016 were 6,3
per cent, up from 6,2 per cent. Average expectations for 2017 were unchanged at
6,2 per cent and were marginally down to 5,9 per cent for 2018. Expectations of
business people were more or less unchanged compared to the previous quarter.
Both analysts and trade union officials revised up their near-term forecasts, while
forecasts for 2018 were revised lower. Average 5-year inflation expectations
declined from 6,1 per cent to 5,9 per cent in the second quarter, with downward
revisions by all groups.
The median expectations of market analysts, as reflected in the Reuters Econometer
survey conducted in July, show a moderate decline since May. Inflation expectations
declined from 6,7 per cent and 6,4 per cent in 2016 and 2017, to 6,6 per cent and
6,1 per cent. The yield differential between inflation linked bonds and conventional
government bonds (break-even inflation expectations) declined across all maturities
but remain elevated.
The global economic outlook has been influenced by the outcome of the UK
referendum. The financial markets displayed a high degree of volatility in the
immediate aftermath of the outcome, but have stabilised to some extent since then.
Nevertheless the longer term real impacts are expected to be negative for global
growth, particularly for the UK and Europe, as investment decisions are put on hold
during the transition period. A high degree of uncertainty is expected to persist for

some time as the magnitude of this slowdown is still unclear and dependent on the
nature and speed of the UK disengagement. Since the referendum, global growth
forecasts have generally been revised down.
The outlook for emerging markets has remained relatively subdued, with further
downside risks in Turkey following the recent coup attempt and terrorist attacks.
Recent outcomes in China indicate some improvement in the growth prospects in
response to government stimulus packages, and this has underpinned a stabilisation
and moderate upward trend in commodity prices. The IMF growth forecasts released
earlier this week have revised sub-Saharan African growth downwards. The region
has been negatively impacted by lower commodity prices and severe drought in
some parts.
Inflation in the advanced economies remains low and still generally below target. The
Brexit vote has also modified expectations regarding monetary policy in these
economies. Although the Bank of England kept policy rates on hold at its most recent
meeting, expectations are for a reduction in the policy rate in the near future, with the
prospect of a resumption of quantitative easing. Markets are now expecting the US
policy rate to remain unchanged for some time. At the same time, the highly
accommodative monetary policy stances of the ECB and Bank of Japan are
expected to persist, with the possibility of additional stimulus.
These developments have reinforced the global search for yield, as yield curves
flattened across major advanced economy markets. The number of government
bonds trading with negative yields increased further. This has provided additional
impetus to renewed capital flows to emerging markets observed since earlier this

year. While these flows are expected to persist, they remain sensitive to changes in
expectations regarding US monetary policy and general global risk perceptions.
The recent volatility experienced by the rand exchange rate has been driven mainly
by external factors and changes in global risk perceptions. Although the rand
depreciated sharply in the immediate aftermath of the referendum, it has reversed
these losses, and more so against the British pound. Since the previous meeting of
the MPC, the rand has traded in a range of R15,80 and R14,22 against the US
dollar, and has appreciated by 11,0 per cent against the US dollar, by 12,9 per cent
against the euro and by 23,0 per cent against sterling. On a trade-weighted basis,
the rand has appreciated by 12,2 per cent.
The rand has been supported by the global search for yield. There was a sharp
increase in non-resident inflows to the domestic bond and equity markets in June
and July. Since the beginning of June, net purchases by non-residents of R107,3
billion have been recorded. The rand also responded positively to the improvement
in commodity prices, and the unexpectedly large trade surplus recorded in May
which followed a small surplus in April. Despite this recent strength, the rand remains
vulnerable to possible “risk-off” global scenarios; changes in US monetary policy
expectations; and domestic concerns including the possibility of ratings downgrades
later in the year.
The domestic economic growth outlook remains extremely challenging, following the
contraction in GDP in the first quarter of this year. Although this is anticipated to
have been the low point of the cycle, the recovery is expected to be weak. The
Bank’s latest forecast is for zero per cent growth in 2016, compared with 0,6 per cent
previously. Growth rates of 1,1 per cent and 1,5 per cent are forecast for the next

two years, down from 1,3 per cent and 1,7 per cent previously. The Bank’s estimate
of potential output has been revised down marginally to 1,4 per cent in 2016, rising
to 1,7 per cent in 2018. This growth outlook is corroborated by the persistent
negative trend in the Bank’s leading indicator of economic activity. Business
confidence remains low with the RMB/BER business confidence indicator falling to
its lowest level since 2009 in the second quarter of this year.
Recent economic data suggest that positive growth was recorded in the second
quarter, with the mining and manufacturing sectors expected to add positively to
growth. The more positive trend in manufacturing is consistent with the Barclays PMI
which has been above the neutral 50 level since March. The BER manufacturing
confidence index also improved, but still remains at low levels. The real value of
building plans passed is indicative of some improvement in the sector, particularly
with respect to residential construction. However, this is not reflected in the
FNB/BER building confidence index which declined further in the second quarter.
Underlying the negative performance of the economy during the first quarter was the
sharp contraction in growth in gross fixed capital formation for the second
consecutive quarter, by both the private sector and general government. These
trends have contributed to the persistence of high rates of unemployment in the
economy. Although formal non-agricultural employment increased in the first quarter
of 2016, this was largely due to temporary employment opportunities created by the
Independent Electoral Commission. By contrast, private sector employment
contracted during the first quarter.
Growth in consumption expenditure by households also contracted in the first
quarter, with a sharp slowdown in expenditure on durable goods in particular. The

FNB/BER consumer confidence index declined in the second quarter to low levels,
following a moderate improvement in the previous quarter. The BER retail
confidence index also declined sharply in the second quarter. While new vehicle
sales remained weak, vehicle exports recorded strong growth in the second quarter.
Despite the surprise increase in retail and wholesale trade sales in May,
consumption expenditure by households is expected to remain subdued given the
low consumer confidence, high debt levels, rising costs of debt servicing, and slow
employment growth. Consumption expenditure has been further constrained by the
absence of significant wealth effects owing to the weak performance of asset
markets, particularly the housing market. Credit extension to households also
remains weak, with negative real rates of growth. Average wage growth has
remained relatively stable, but there are risks of increases in excess of inflation and
productivity gains.
There are as yet no clear signs of a recovery in the agricultural sector, and food price
inflation is expected to remain elevated for some time. The Bank expects food price
inflation to peak at 12,6 per cent during the final quarter of this year. There are some
encouraging signs of moderation in some food categories at both the producer and
consumer price levels, and futures prices of grains have declined markedly. Should
food prices stabilise or decline in the coming months, there is the potential for
significant downside base effects next year. Exchange rate developments will also
be critical in this respect, as will global food prices, which have reversed their recent
negative trend.
Despite supply disruptions and curtailments by a number of producers, the price of
Brent crude oil has mostly traded within a band of US$45 and US$50 since the

previous meeting of the MPC. The Bank’s model assumes a very moderate upward
trend in oil prices over the forecast period, but there may be a degree of downside
risk in the short term, with some upside risk in the outer period as global demand
recovers. The domestic petrol price increased by a cumulative 60 cents per litre in
the past two months, due to both the exchange rate and international prices.
However, the recent appreciation of the rand coupled with a lower average oil price
has resulted in a substantial over-recovery in the petrol price, and a sizeable
reduction in retail prices is expected in August.
The Monetary Policy Committee remains concerned about the weak economic
growth outlook and the medium term inflation trajectory which remains outside the
target range of 3 to 6 per cent until the second half of next year. Nevertheless there
have been some improvements in the near term inflation prospects following
successive downside surprises. This is also the case for core inflation, where the
expected breach of the upper end of the target range is now less protracted. While
the risks to the inflation forecast are assessed to remain on the upside, these risks
have moderated somewhat.
Global uncertainties appear to have delayed monetary policy tightening in advanced
economies. The impact of the more appreciated rand exchange rate on the inflation
outlook will depend to a large extent on whether the exchange rate is sustained at
these stronger levels. Current exchange rate levels are stronger than those implicit in
the forecast, providing some buffer to the projections. The rand remains sensitive to
both domestic and external developments, and the recent trends can be quickly
reversed.

The outlook is clouded by the uncertainty surrounding the longer term market and
global growth implications of Brexit. The implications for the rand and domestic
growth, and ultimately inflation, could vary quite significantly depending on which
scenario plays out.
A weaker global growth scenario could also imply that there may be a degree of
downside risk to the international oil price assumption, which was adjusted upward.
A combination of a stronger exchange rate and subdued international oil prices
would have a favourable impact on domestic petrol prices in the coming months.
However, the committee assesses the longer term risk to this assumption to be on
the upside, as global growth and oil demand are expected to recover.
Food prices remain an upside risk in the near term. There could however be a sharp
decline in agricultural prices next year should favourable weather patterns transpire
as forecast. The absence of demand pressures and weak consumption expenditure
growth may also contribute to downside risks.
While the committee remains concerned about the overall inflation trajectory, the
assessment of the balance of risks to the inflation outlook and the weak domestic
economy has provided some room to delay further tightening of the monetary policy
stance for now. Accordingly the MPC has unanimously decided to keep the
repurchase rate unchanged at 7,0 per cent per annum.
The MPC is aware that some of the favourable factors that contributed to this
decision could reverse quickly, and remains ready to react appropriately to any
significant change in the inflation outlook.

Lesetja Kganyago

GOVERNOR
Contact person:
Candice Jeffreys
+27 12 313 4209