Monetary Policy Review
October 2017
South African Reserve Bank
Monetary Policy Review
October 2017
Monetary Policy Review October 2017
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ISSN: 1609-3194
Monetary Policy Review October 2017
Preface
The primary mandate of the South African Reserve Bank (SARB) is to achieve and maintain price stability in the interest of
balanced and sustainable economic growth. In addition, the SARB has a complementary mandate to oversee and maintain
financial stability.
Price stability helps to protect the purchasing power and living standards of all South Africans. It provides a favourable
environment for investment and job creation, and also helps to maintain and improve international competitiveness. The goal
of price stability is quantified by the setting of an inflation target after consultation with the government. The SARB has full
operational independence. Monetary policy decisions are made by the SARB’s Monetary Policy Committee (MPC), which is
chaired by the Governor and includes the deputy governors as well as other senior officials of the SARB.
The MPC conducts monetary policy to keep inflation within a target range of 3–6%. This inflation targeting-framework is
flexible, meaning that inflation may be temporarily outside the target range, under certain circumstances. The MPC takes
into account the time lags between policy adjustments and economic effects. This provides for interest rate smoothing over
the cycle, and contributes towards more stable economic growth. The decision of the MPC, together with a comprehensive
statement, is communicated at a media conference at the end of each meeting.
The Monetary Policy Review (MPR) is published twice a year and is aimed at broadening public understanding of the
objectives and conduct of monetary policy. The MPR covers domestic and international developments that impact on
the monetary policy stance. It is fundamentally a forward-looking document which focuses on the outlook for the South
African economy, in contrast to the Quarterly Bulletin which records and explains recent economic developments.
The MPR is presented by senior officials of the SARB at monetary policy forums in various centres across South Africa in an
effort to develop a better understanding of monetary policy through direct interactions with stakeholders.
Monetary Policy Review October 2017
Contents


Boxes


Statements issued by Lesetja Kganyago, Governor of the South African Reserve Bank
Statement of the Monetary Policy Committee

Statement of the Monetary Policy Committee

Statement of the Monetary Policy Committee


Monetary Policy Review October 2017
Introduction
Inflation fell back to within the 3–6% target range in April and
is expected to remain within the target range over the medium
term. Inflation forecasts have improved during the year; headline
inflation is now projected to average 5.3% in 2017, 5.0% in 2018
and 5.3% in 2019, while core inflation should be close to 5% for
all three years. By contrast, the domestic growth outlook has
deteriorated, despite a sustained acceleration in global growth.
Lower inflation has created some space for monetary easing,
permitting a reduction in the repurchase (repo) rate to 6.75% in
July. Over the longer run, lower interest rates will require more
sustained improvements in the inflation forecast.
The world economy has strengthened over the past year. The
major advanced economies are experiencing synchronised
recoveries: growth is running above potential in the euro area,
Japan and the United States (US), and labour markets have
tightened. Despite this reduced slack, inflation rates in these
economies remain below targets. Monetary policy settings
are therefore expected to remain broadly expansionary.
Nonetheless, the degree of stimulus is likely to be reduced,
with higher interest rates and balance sheet tapering in the
US as well as a reduced pace of quantitative easing in the
euro area.
Emerging market growth has also improved. In particular,
growth in China beat expectations in the first half of the
year, interrupting a five-year deceleration trend. Other large
emerging markets are also doing better, with Brazil and
Russia out of recession and India rebounding from recent
shocks (mainly demonetisation and uncertainty over a new tax
system). Inflation rates have moderated significantly in most
large emerging markets economies, permitting central banks
to lower interest rates.
This environment has stoked a risk-on mood in global financial
markets. Volatility has fallen to unusually low levels and the
search for yield has intensified: equity valuations are high, bond
yields remain low and capital flows to emerging markets have
been robust. Exchange rates have also shifted. With the US
no longer the sole major economy in recovery, the US Federal
Reserve (Fed) is shedding its status as the only big central bank
which is tightening policy. This change has already contributed
to a less appreciated US dollar, with the Fed’s broad dollar
index down around 10% so far this year.
Despite this favourable combination of strong global growth
and easy financing conditions, South Africa’s economy remains
stagnant. Output has been nearly unchanged over the past
two years, and in per capita terms South Africans are poorer

Inflation target range
Percentage change on a year earlier (both scales)
Targeted inflation* forecast

* CPI for all urban areas
Sources: SARB and Stats SA
Credibility and countercyclicality: monetary policy
responses to lower inflation and low growth
Index
Asian crisis
Global financial
crisis
European
debt crisis

VIX
Source: Bloomberg

Monetary Policy Review October 2017

than they were in 2014. The current account has narrowed
sharply, mainly due to import compression. This has restored
a degree of external balance to the economy, moderating
South Africa’s external vulnerability and contributing to a less
volatile exchange rate. Yet reduced investment weakens the
economy’s growth potential: estimates now indicate trend
growth has fallen below 1.5%, down from 3–4% in the 2000s.
Furthermore, low growth has undermined National Treasury’s
fiscal consolidation plans. With public debt rising faster than
planned, macroeconomic balance remains elusive.
Domestic growth has stalled because of political and policy
uncertainty, which has depressed household and business
confidence. Confidence indicators have been below longerterm averages since late-2015, when the serving finance
minister was unexpectedly dismissed, and are currently about
as low as they were during the global financial crisis. In these
circumstances, investment has contracted and household
consumption growth has slowed to a crawl. The forecast
indicates a feeble recovery over the next two years, but even in
2019 expected growth barely exceeds 1.5%.
While the growth forecast has deteriorated over the course of
the year, the outlook for consumer prices has improved. Inflation
returned to within the target range in the second quarter of
2017, as forecast, and the extent of the deceleration has been
somewhat better than first expected. The previous Monetary
Policy Review (MPR), published in April 2017, anticipated
inflation at 5.8% for the second quarter; in fact, inflation
averaged 5.3%. The surprise was mainly due to exchange rate
effects, with import prices falling abruptly. Inflation has also
benefitted from reduced food price inflation and a temporary
slowdown in electricity price increases.
The latest forecast suggests inflation will moderate to a low of
4.6% in the first quarter of 2018, before trending somewhat
higher to average 5.3% in 2019. The uptick in inflation in the
outer part of the forecast is explained by several factors.
First, the electricity and oil price assumptions are higher for
this period. Second, food and import prices are expected to
normalise during 2018, following rapid increases in 2016 that
have been largely reversed in 2017. Third, the forecast includes
slightly stronger growth in 2018 and 2019, which narrows the
output gap. Finally, persistently positive real wage gains put
a floor under inflation, causing it to stabilise above 5% after
the disinflationary shocks abate. Lower inflation over the next
few quarters may help moderate inflation expectations, but
the forecast already entails an historically low growth rate for
unit labour costs (remuneration adjusted for productivity), and
evidence for a stronger decline is still scarce.


* At seasonally adjusted and annualised rates
Sources: SARB and Stats SA
Percentage change* from quarter to quarter (both scales)
Real GDP growth

Index: 2015 = 100

Business confidence
Source: SACCI

Percentage change
Mar May
Sep
Jul
Jan
Mar
Sep
May
Jul
Nov

Evolution of inflation forecasts
MPC meeting

Source: SARB


Monetary Policy Review October 2017
Overview of the monetary
policy stance
In recent years, monetary policy has confronted rising inflation
alongside slowing growth. This dilemma has eased somewhat
in 2017 because of lower inflation. However, the improvement
in inflation has been repeatedly jeopardised by negative
domestic shocks, such as downgrades by the ratings agencies
as well as the Public Protector’s proposed amendment to the
South African Reserve Bank’s (SARB) constitutional mandate.
Furthermore, both inflation and inflation expectations have
stayed well above the midpoint of the target range – even as
global inflation rates have settled at historically low levels.
In these circumstances, successive Monetary Policy
Committee (MPC) statements signalled first a pause, and then
an end, to the policy tightening cycle. By July 2017, inflation
had slowed enough to permit a quarter-point reduction in the
repo rate – the first decrease since 2012. At this juncture,
the four-quarter-ahead inflation forecast was down to 4.6%,
close to the midpoint of the target range and below the
average forecast at MPC meetings where rates have been
cut historically. Additionally, because inflation rates had
decelerated more rapidly than expected, real ex ante interest
rates – defined as the nominal repo less projected inflation
– had shifted abruptly higher. The July rate cut helped to
moderate the real rate trajectory.
Inflation risks also looked more balanced in July, bolstering
the case for lower rates. This judgement mainly reflected
slower advanced economy inflation, implying major central
banks could normalise policy more gradually than previously
expected. Unfortunately, this favourable shift in the external
environment was not matched by receding domestic risks.
By the September MPC meeting, these risks had come more
clearly into view. Forecast scenarios showed electricity price
increases could add 0.2–0.3 percentage points to headline
inflation, potentially prompting second-round effects. The
exchange rate outlook also worsened, not least because
disappointing fiscal revenues increased the probability of
additional credit ratings downgrades. As a result, the overall
inflation risk assessment skewed back towards higher inflation,
curtailing space for another cut.
The medium-term challenge for monetary policy is to anchor
inflation and inflation expectations more firmly within the
inflation target. There are a range of costs to having inflation
fluctuating at around 6%. One is that relatively high and volatile
inflation keeps borrowing costs high; most other countries,
including many of South Africa’s peer emerging markets,
enjoy lower interest rates as a result of having lower inflation.
A related consideration is that South Africa’s competitiveness
suffers from relatively high inflation because local prices rise
significantly faster than foreign prices. Advanced economies
mostly target inflation of 2%, and emerging market targets
are converging on targets in a range between 3–4%. This
has made an implicit inflation target close to 6% increasingly
uncompetitive. Finally, tolerating inflation around the upper
Per cent
Four-quarter-ahead inflation forecasts for
historical rate cuts
Source: SARB
Dates of rate cuts

Sep 01
Jun 01
Aug 03
Jun 03
Oct 03
Sep 03
Aug 04
Dec 03
Dec 08
Apr 05
Mar 09
Feb 09
Aug 09
May 09
Sep 10
Mar 10
Jul 17
Jul 12
Nov 10
Average 5.2
Per cent
2000 2002 2004 2006 2008 2010 2012 2014 2016
South African repo and prime rate
Source: SARB

Prime rate

Repo rate

Percentage change over four quarters

Changes to the SARB’s inflation forecast*
Sources: SARB and Stats SA

Mar 2016

Sep 2016

Mar 2017

May 2017

Jul 2017

Sep 2017

Actual
* Dotted lines indicate forecasts

Monetary Policy Review October 2017

end of the target range raises the probability of target misses,
even though the target is already comparatively wide. These
challenges can be overcome by lowering inflation towards the
midpoint of the inflation target over time.
In the shorter term, monetary policy also has a countercyclical
role to play. As the SARB has been communicating for some
time, South Africa’s economic stagnation over the past few
years is largely due to a weak export response, high household
debt stocks and falling investment caused by uncertainty.
These problems have not been responsive to demand-side
policies, including relatively low short-term interest rates. Yet
some portion of the current slowdown is attributable to cyclical
weakness, reflected in a negative output gap. The July interest
rate cut is helping offset this demand shortfall, providing a
measure of support to the economy at a difficult time.
The current monetary policy settings reflect these two
objectives: lowering inflation so that it is securely anchored
nearer the midpoint of the inflation target range, while
exploiting available policy space to offset cyclical weakness
in the economy. Together, these objectives serve the SARB’s
mandate to protect the value of the currency in the interest of
balanced and sustainable growth.
Box 1 Introducing the Quarterly Projection Model
Inflation targeting is fundamentally forward-looking, and therefore requires forecasts. These forecasts are produced with the help of a suite of
models. Since 2000, the Core Model1 has served as the frontline model responsible for the headline growth and inflation forecasts. However,
the Monetary Policy Committee (MPC) will soon be promoting the Quarterly Projection Model (QPM) to this position, while retaining the Core
Model in a supporting role. This box provides an introduction to the QPM.2
At the heart of the QPM are four main ‘gaps’: output, inflation, the real exchange rate and the real interest rate. A shock to the economy will
create gaps between the equilibrium and actual values of these variables.3 In response, the model will produce a path that closes these gaps
and brings the economy back into equilibrium. For example, if inflation rises above the target, the real interest rate will rise relative to its neutral
level (following a Taylor rule – see Box 3). This appreciates the exchange rate and dampens domestic demand, widening the output gap. Inflation
then falls back to the target, and the interest rate ultimately returns to its neutral value.
One virtue of the QPM is its simplicity. It is a popular misconception that econometric models are black boxes, with economists inputting data
and relying on the models for the results. However, models are merely inputs into the forecasting process. They assist economists by ensuring
consistency between various assumptions and interactions. Because judgement is also a significant input in forecasting, model simplicity
supports clarity of thought and transparency.
Another advantage is that in the QPM, the exchange rate and the repurchase (repo) rate adjust endogenously to economic events. By contrast,
the convention with the Core Model has been to keep the repo rate fixed at the level decided at the previous MPC meeting. Similarly, the real
effective exchange rate is assumed to remain stable across the forecast. Because these variables do not respond to changes in the economic
environment, forecasts from the Core Model do not always reflect the most likely outcomes. Rather, they provide an indication of economic
developments in the absence of monetary policy changes. By contrast, the QPM has the repo rate follow a Taylor rule, while the exchange rate
responds to an uncovered interest parity condition. This means the QPM should produce more accurate forecasts.
The QPM does, however, pose some communication challenges. In particular, the projected path for the repo rate should not be seen as a policy
commitment, and at times the MPC may set rates differently (for instance, if the MPC believes there are skewed risks to the forecast). Exchange
rate forecasts will also typically be wrong in the shorter term, simply because of market volatility. However, these challenges have been
surmounted by the many other central banks that use QPM-style models, and should prove as manageable in South Africa.
1 D Smal, C Pretorius and N Ehlers, ‘The core forecasting model of the South African Reserve Bank’, South African Reserve Bank Working Paper Series No.
WP/07/02, June 2007.
2 B Botha, S de Jager, F Ruch and R Steinbach, ‘The quarterly projection model of the SARB, South African Reserve Bank Working Paper Series No. WP/17/01,
September 2017.
3 Generally speaking, the economy is in equilibrium when supply equals demand. Equilibrium in the QPM is when output is at potential and inflation
is on target.
Five-year-ahead inflation forecast (per cent)
Five-year yield (per cent)
Inflation expectations and borrowing costs
Sources: Bloomberg and IMF
Turkey
Brazil
Russia
South Africa
Mexico
Peru
Poland
Thailand
Hungary
Chile
Phillippines

Monetary Policy Review October 2017
Box 2 Interpreting estimates of the South African neutral
real interest rate
The neutral real interest rate (NRIR) is a central concept in monetary
economics. It is defined as the interest rate consistent with stable
inflation and an economy operating at full potential. If policy is above
the neutral rate, everything else being equal, inflation falls and growth
slows, while a policy rate below neutral has the opposite effect. For
this reason, the NRIR is the basis for characterising a given policy
stance as expansionary, contractionary or neutral.
Unfortunately, the neutral rate is difficult to specify with much
certainty. Unlike other indicators of economic activity, such as gross
domestic product, unemployment or inflation, it is unobservable and
therefore has to be estimated. There are various methods for doing
this, ranging from simple historical averages or a Hodrick-Prescott
filter to more complex econometric techniques. These methodologies
yield a broad range of estimates; for instance, internal research has
generated point estimates for 2015 that range from -1.5% to 2%.
The South African Reserve Bank’s Quarterly Projection Model (QPM)
(described in Box 1) uses an estimate constructed from the global real
neutral rate, a country risk premium and changes in the equilibrium
real exchange rate. This approach suggests the NRIR is currently
around 1.5%. More recent research applying the methods pioneered
by Laubach and Williams yields similar conclusions.1
The imprecision of NRIR estimates means policymakers have to use
them cautiously. However, the available research supports several
substantive conclusions. First, over the course of inflation targeting,
monetary policy has mostly been either neutral or expansionary.
Different estimates generally concur that episodes of tight monetary
policy have been few and short-lived (see figure). Second, the neutral
rate in South Africa has fallen significantly in the post-crisis period,
which is consistent with the experience of other countries. Third, as
the inflation rate slowed in mid-2017, the real interest rate moved
briefly above neutral. This helped motivate the Monetary Policy
Committee’s July rate cut.
1 L Kuhn, F Ruch and R Steinbach, ‘Reaching for the (r)-stars: estimating
South Africa’s neutral real interest rate’, paper presented at the biennial
conference of the Economic Society of South Africa, 30 August–
1 September 2017.
Contractionary
Per cent

Real interest rate gap
Source: SARB
Real interest rate gap
(Sep 2017)
Real interest
rate gap
(Jul 2017)
Expansionary
-3
-2
-1

Per cent
2000 2002 2004 2006 2008 2010 2012
2014 2016
NRIR and its uncertainty

90%

30%

60%

Real interest rate (ex ante)
-1

Source: SARB
Monetary Policy Review October 2017

Box 3 The Taylor rule: ‘look what you made me do’1
Taylor rules offer simple guidelines for monetary policy decisions. They
are named after the economist John Taylor, who showed that interest
rate decisions by the United States Federal Reserve usually followed
a straightforward rule-of-thumb based on inflation and growth.2
Taylor-type rules have since been developed for many countries, and
are widely consulted by central banks, academic economists and
analysts.
The South African Reserve Bank’s Quarterly Projection Model (QPM
– see Box 1) allows the policy rate to adjust to changing conditions
following a Taylor-type rule.3 This rule starts with a neutral rate of
interest (described in Box 2). Policy then moves from the neutral rate
based on how far expected inflation is from the target (inflation gap)
and how far growth is from potential (the output gap).4 The QPM
Taylor rule also has a large smoothing parameter, which means
previous interest rate decisions influence the future rate path. This
reduces the volatility of the rate forecast, keeping it in line with actual
policy behaviour.
The QPM Taylor equation is not necessarily the best guide to South
African monetary policy. The weights assigned to the different
variables in the rule may be contested. The equation also does not
explicitly distinguish between supply- and demand-side shocks.
Finally, estimates of the true neutral rate or the actual potential growth
rate are uncertain. For these reasons, the Taylor rule is just one of
many inputs into policy decisions.
Those caveats aside, assessing policy against the Taylor rule yields
several points. One is that policy decisions do not focus exclusively on
inflation; a Taylor rule with a zero weight for growth does not fit the
data. Rather, monetary policy plays a countercyclical growth role, and
it does this more firmly when inflation is well behaved. Second, if the
smoothing parameter is relaxed, the Taylor rule indicates the actual
repo rate was below the Taylor rule level through much of the postcrisis period. This may reflect overestimation of the output gap at the
time. It also suggests monetary policy was making an unusually large
effort to raise growth – albeit without much success. Finally, the Taylor
rule predicted a decrease in the repo rate in the third quarter (although
it smoothed the adjustment over the entire quarter, not being obliged
to wait for MPC meetings or to move in discrete 25 or 50 basis point
increments). Once this adjustment was achieved, the model saw no
need for an additional cut. Indeed, over the forecast period, it shows
rates rising again in 2019, which is due to the combination of a less
negative output gap, a higher neutral rate (mainly given higher interest
rates in advanced economies) and a persistent overshoot of the
model’s longer-run 4.5% target.
1 Actually, we are responsible for our own actions. This is not a Taylor
Swift rule.
2 J B Taylor, ‘Discretion versus policy rules in practice’, 1993, available at

3 The precise QPM Taylor rule is as follows:

where the nominal repurchase rate (it ) is modelled as the sum of the past
nominal repurchase rate, lagged by one quarter (it–1); the neutral nominal
repurchase rate (i t); the forward-looking CPI inflation gap
(Eπt+3 + Eπt+4 +Eπt+5) – π*; and the output gap (yt – y t ).
4 In the QPM rule, the target is set at 4.5%, the midpoint of the 3–6% range.
The model requires a point target because it cannot solve for an entire
target range. For forecasting purposes, the MPC has chosen to use the
middle of the target range as that point.
Per cent
-3

Decomposition of the Taylor rule repo rate

Neutral repo rate

Output gap

Inflation gap

Repo rate

Source: SARB
Per cent

2010 2012 2014 2016 2018
Actual repo rate compared to Taylor rule guideline
Source: SARB
SARB's Taylor rule
repo rate
Actual repo rate

* 1
*
it = 0.79it–1+ (1 – 0.79){i t +1.57 [3 (Eπt+3 + Eπt+4 +Eπt+5 ) – π*] + 0.54(yt – yt )} + εt

Monetary Policy Review October 2017
A global economic upswing
Global growth has accelerated since the previous MPR,
making the current upswing the most sustained of the postcrisis period. Previously identified risks to the world economy
have also receded: China, in particular, appears to have averted
an abrupt slowdown. Yet the recovery is still missing two
important pieces. First, inflation rates in advanced economies
remain stubbornly below targets, delaying the process of
monetary policy normalisation. Second, productivity growth
continues to be very subdued, with long-run implications for
living standards.
Advanced economies: more
growth than inflation
At the beginning of 2017, advanced economy growth and
inflation forecasts were more or less equally promising.
Growth was running above potential and output gaps were
nearly closed, while labour markets appeared to be near full
employment. With little or no spare capacity remaining in these
economies, inflation rates seemed likely to stabilise at targeted
levels. This left the way open for central banks to normalise
policy to prevent inflation from overshooting.
In recent months, growth projections have improved further,
particularly in Japan, the euro area and Canada – but inflation
forecasts have shifted down again. Lower inflation has been
partly due to lower energy prices, yet inflation and wages are
also not reacting as expected to full employment and higher
growth. The historical relationships between these variables
may yet re-emerge, producing upside inflation surprises. At
this moment, however, advanced economy central bankers
face the possibility that the normal transmission mechanism of
monetary policy has weakened.
In the US, growth should exceed 2% annually for the 2017–
2019 period, although substantial fiscal stimulus now appears
unlikely. Unemployment remains very low, having fallen as low
as 4.3% in July 2017 – below most estimates of the ‘natural’
rate of unemployment. Broader measures of labour market
health are similarly encouraging: for instance, quit rates and
job opening rates are back at pre-crisis levels. The US recovery
since the global financial crisis has not been the fastest on
record but it has been one of the longest, having so far lasted
more than nine years. Although this suggests a recession is
overdue, over the post-war period the duration of recoveries
has not been an effective predictor of their remaining lifespan:
expansion phases have not died of old age.1

G D Rudebusch, ‘Will the economic recovery die of old age?’,
FRBSF Economic Letter No. 2016-03, 8 February 2016.
Percentage change

Evolution of forecasts for 2017 growth and inflation
for G3 economies*
* Weighted using 2016 PPP GDP weights
Sources: Consensus Economics, IMF and SARB

Real GDP

Consumer inflation

Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov
Percentage of potential GDP

Output gap
Source: SARB
United States
Euro area
Japan

Monetary Policy Review October 2017

While the US has been the best-performing major advanced
economy through much of the post-crisis period, Japan and
the euro area have recently matched its performance. In both
these cases, growth is now expected to peak this year at levels
close to 2%, before reverting to trend levels in 2018 and 2019
(the International Monetary Fund (IMF) expects 1.6% for the
euro area in both these years, and 0.6% and 0.9% for Japan).
The Japanese economy is enjoying its longest expansion
phase in more than a decade (and the third-longest in its postwar history), and unemployment has fallen to just 2.8% of the
workforce, with the number of jobs available now exceeding
applicants by 50%. Euro area growth has been stronger than
Japan’s, and the region has also outpaced the US over the
past two years (with output up 4.1% since the middle of 2015,
versus 3.5% in the US). Euro area unemployment, however,
remains elevated at nearly 9%, although it has fallen from crisisera peaks and is now back at 2005 levels (if not the 2007/08
trough of almost 7%).
Despite stronger growth, inflation rates in all these economies
have slowed. In the US, personal consumption expenditure
(PCE) inflation overshot the Fed’s target in February, reaching
2.2%, but it has since shifted lower, to 1.4% in July. Similarly,
core inflation peaked at 1.9% in January 2017, but has now
slumped back to 1.5%; it has been more than five years since
core inflation was above 2%. Inflation rates in the euro area
have been lower still. Headline inflation also peaked in the first
half of the year, reaching 1.9% in April (and 2.3% in Germany),
but subsided to 1.4% in May. Japanese inflation remains close
to zero, as it has for three decades.
Reflecting on these trends, it is clear a surge in oil prices was
responsible for higher inflation in the first few months of the
year. More broadly, supply shocks of one type or another
explain most of the increases in advanced economy inflation
over the post-crisis period. Japan’s year of above-target
inflation was caused by a value-added tax (VAT) increase;
less idiosyncratically, super-loose monetary policies have
transmitted to inflation mainly through exchange rates. This
is an unreliable basis for achieving inflation targets. Not all
countries can depreciate at the same time. Furthermore,
supply shocks are necessarily temporary and will drop out
of inflation measures after 12 months – unless they change
broader wage and price-setting behaviour.
To achieve inflation targets more consistently, advanced
economy central banks need wage growth and aggregate
demand to generate stronger price pressures. There are
several reasons why this may not be happening. As the
Japanese example demonstrates, labour markets can
become extremely tight without sparking inflation. This may be
because additional labour demand is met with higher labour
force participation, meaning the labour supply adjusts instead
of the price. Alternatively, conditions of employment may
improve instead of wages, for example, through a part-time
post becoming permanent. More broadly, labour shares of
Per cent

Evolution of US real GDP forecasts
Sources: IMF and SARB

Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov
Percentage change over 12 months (both scales)

G3 inflation* and energy prices
* Weighted by purchasing power parity
Sources: Bloomberg and SARB

Brent crude oil (right-hand scale)

Headline inflation

Core inflation


Percentage change over 12 months

Targeted inflation

2017 average

Inflation target

Five-year average

Target range
Canada
Euro area
Japan
South Korea
Sweden
Switzerland
United Kingdom
United States
Norway
Australia
Sources: Haver and respective central banks

Monetary Policy Review October 2017
output have fallen in many economies, so labour markets have
less influence on economy-wide prices than they used to.2
Furthermore, globalisation and other supply-side advances
may be exerting enough disinflationary force to overwhelm
demand-side factors.3
Although longer-term inflation expectations appear to be on
or close to target in most advanced economies, central banks
tend to be more pessimistic. The European Central Bank (ECB)
staff forecast indicates inflation will be at 1.6% in 2019, while
the Bank of Japan projects inflation at 1.5% by March 2019
(compared with targets of 2% in both cases). The Fed’s ‘dot
plot’ is an exception, with the median inflation projection at
2% for 2018 and 2019. Market participants, however, expect
a markedly lower path for inflation and the federal funds rate.
Emerging market growth accelerating
Emerging market economic growth accelerated in the first half
of 2017. The IMF’s World Economic Outlook forecasts indicate
further improvements in emerging market performance, with
overall growth rising to 4.6% in 2018 and 4.8% in 2019, from
4.3% in 2016. India’s economy appears to be returning to growth
rates over 7%, following the demonetisation shock of late-2016
– in which almost 90% of the cash in circulation was declared
invalid – as well as uncertainties over the new General Sales
Tax system. China’s economy has beaten expectations over
the first two quarters of the year, with growth averaging 6.9%.
Short-term indicators point to a slowdown in Chinese growth in
the second half of 2017, explained by fading fiscal stimulus and
new policy measures to slow debt accumulation and contain
property prices. Over the medium term, growth is likely to be
close to the government’s 6.5% goal, although the sustainability
of this growth depends crucially on debt stabilising.
There are relatively few exceptions to the emerging market
acceleration trend. One is Brazil: first-quarter data suggested
the economy was finally recovering, but growth slowed again in
the second quarter amid a resurgence of political uncertainty.
Gross domestic product (GDP) is still about 8% below the
2014 peak. Another is Venezuela, which is experiencing the
worst economic crisis in its history, with output down around
35% since 2013. Growth in sub-Saharan Africa appears to be
picking up from 2016’s long-term low (of 1.3%), but projections
are still well below the longer-term trend (at 2.7% for 2017 and
3.5% for 2018, according to the IMF, versus a 2000–2015
average of 5.5%).
Inflation in major emerging markets has slowed this year,
concluding a period in which many economies grappled with
above-target inflation. For instance, inflation in Brazil decelerated
from 6.3% in 2016 to just 2.7% as of July 2017. Indian inflation
reached 2.4% in July, from 4.5% in 2016; and Russian inflation
fell to 4.4% in June, from a 2016 average of 5.4%. With inflation
rates now generally below targets, emerging market central

International Monetary Fund, World Economic Outlook, Chapter 3,
April 2017.

Bank for International Settlements, Annual Report 2016/17, 2017.
Index
2001 2003 2005 2007 2009 2011 2013 2015 2017
Diffusion index of GDP growth in emerging
market countries
Sources: IMF and SARB
Forecast
More economies accelerating
More economies decelerating

Monetary Policy Review October 2017

banks have had room to cut rates. Analysts’ forecasts suggest
rates will, on balance, decline further until mid-2018, although
the trend reverses course in the second half of that year with a
plurality of central banks expected to raise rates again.
The productivity problem
For all the optimism engendered by the global upswing, there
is still little evidence of rising productivity growth. Productivity
represents how efficiently the factors of production are used. It
is usually measured as the portion of growth left unexplained
after accounting for changes in capital or labour, although
it is also often discussed in terms of output per worker (i.e.
labour productivity). Productivity growth matters because it is
the most important determinant of long-run living standards.
Furthermore, as demographic factors start to constrain
labour force growth in most parts of the world, it will become
increasingly difficult to achieve robust economic growth
without a productivity recovery.
In advanced economies, productivity growth has slowed
from about 1% annually in the pre-crisis era to just 0.2%
since then. In emerging markets, productivity growth has also
decelerated, from 2.8% between 2000 and 2007 to 1.1% postcrisis. It remains above advanced economy levels, however,
due to emerging markets’ distance from the productivity
frontier. Chinese labour productivity, to take one example,
is still less than a quarter of US labour productivity, despite
several decades of rapid growth.
There are various explanations for lower productivity growth.
One school of thought emphasises the lingering effects of the
global financial crisis (so-called productivity hysteresis). For
instance, the crisis may have left corporate balance sheets
too weak to fund adequate research and development.
Alternatively, capital may have been misallocated from its
best uses, perhaps into unwanted houses, with lasting
consequences. It is also possible that demand has been too
feeble to elicit productivity-enhancing investments. A different
class of explanations relies on longer-term trends, such as
aging workforces, slowing international trade integration or a
fading information technology boom.4 One notable version of
this argument holds that the productivity-enhancing inventions
which transformed living standards between about 1870
and 1970 were simply superior to more recent technological
gains: electricity and indoor plumbing helped more than
Twitter and Siri.5 The opposing view is that a fourth industrial
revolution, based on robots and biotechnology, will still deliver
transformative productivity gains.6

For details on slowing productivity see G Adler, R A Duval, D Furceri,
S Kiliç Çelik, K Koloskova and M Poplawski-Ribeiro, ‘Gone with
the headwinds: global productivity’, International Monetary
Fund Staff Discussion Note No. SDN/17/01, April 2017.

R J Gordon, ‘The rise and fall of American growth: the US standard of
living since the civil war’, 2016.

K Schwab, ‘The fourth industrial revolution: what it means, how to
respond’, January 2016, available at
agenda/2016/01/the-fourth-industrial-revolution-what-it-means-andhow-to-respond/.
Per cent

Total factor productivity

Advanced economies

Emerging market and developing economies

South Africa
Sources: IMF and SARB
-3
-2
-1

Number of countries
Consensus forecasts for changes in emerging
market policy rates
Source: Bloomberg

End-2018
Mid-2018
End-2017

Higher

Unchanged

Lower

Monetary Policy Review October 2017
Global risks
There are a range of risks to the current global outlook. One
of the most important is advanced economy inflation. Upside
inflation surprises could shift policy expectations abruptly,
affecting capital flows worldwide – a scenario discussed in
more detail in the financial markets chapter of this MPR. A
second major risk is China’s growth trajectory. Better growth
outcomes in the first half of the year were paid for with more
debt and larger financial sector imbalances. The political cycle
now favours stabilising the financial system, even at the price
of somewhat lower short-term growth. This adjustment is
likely to be carefully controlled, but long-standing fears of a
‘hard-landing’ remain valid. A third risk, which has intensified
lately, is the possibility of conflict on the Korean peninsula,
which would massively disrupt the fastest-growing part of the
world economy.
Conclusion
The SARB’s forecasts anticipate global growth will peak this
year, at 3.4%, before slowing marginally to 3.3% for 2018 and
2019. Inflation is projected to pick up in advanced economies,
on average getting close to, but not above, targets.
Short-term interest rates will therefore rise moderately, but
remain below longer-term averages. This suggests global
conditions will remain favourable, sustaining what has been
the best and broadest world recovery since the global
financial crisis.
Monetary Policy Review October 2017

Favourable global financial
conditions
The global financial backdrop remains favourable. Riskier
assets – including emerging market assets – are benefitting
from stronger global growth, muted volatility and very low
advanced economy interest rates. These conditions have
supported South African financial assets. Nonetheless, South
Africa has not performed as well as its emerging market peers,
reflecting adverse domestic factors.
Low volatility and low interest rates
Global economic growth has picked up, but inflation in
advanced economies is still very low. Investors expect major
central banks to keep policy expansionary for an extended
period, which is fostering a mix of buoyant financial asset
performance and unusually low levels of volatility (only briefly
interrupted by shocks such as weapons tests by North Korea).
These conditions may foment complacency; historically,
periods of ultra-low volatility have preceded crises.7 For the
time being, however, the world financial environment is good for
growth and uncommonly forgiving of domestic weaknesses.
In contrast to the ‘taper tantrum’ period of mid-2013, financial
markets have confronted the prospect of advanced economy
monetary policy normalisation with a degree of equanimity.
In the US, market participants judge it unlikely that the Fed will
hike interest rates more than twice by the end of 2018 – whereas
the Fed’s own median projections (the ‘dots’) still imply four
more increases over this period. Similarly, interest rate futures
indicate only even chances of a higher ECB deposit rate
next year.
As a result, interest rates in advanced economies remain very
low. Long-term US yields have declined again and the yield
curve has flattened, helped by market expectations that the
Trump administration is unlikely to deliver meaningful fiscal
stimulus. Core eurozone bond yields are lower still, while
peripheral spreads have narrowed. Other asset prices are also
elevated. The US Standard & Poor’s 500 (S&P 500) Index,
for instance, reached an all-time high in September, with its
cyclically-adjusted price earnings ratio above 2008 levels.
Global house prices are also back at around 2008 levels –
although evidence of excessive leverage is restricted to a few
smaller economies.
Emerging market assets have outperformed their advanced
economy counterparts this year. Local currency debt markets
have mostly benefitted from lower inflation and corresponding
monetary easing, while equities have narrowed their valuation
gap (relative to expected earnings) with advanced markets.
Emerging markets may yet prove vulnerable to a faster-thanexpected pace of policy normalisation by major central banks.

J Danielsson, M Valenzuela and I Zer, ‘Learning from history:
volatility and financial crises’, Federal Reserve Board Finance and
Economics Discussion Series No. 2016-093, October 2016.
Ratio

Forward-looking price earnings ratio of the S&P 500
Source: Bloomberg

Per cent

FOMC median forecast and implied market
projections for the federal funds rate
Source: Bloomberg


Federal funds futures (before June 2017 hike)

Federal funds futures (latest)

‘Dots’ median
Index
2000 2002 2004 2006 2008 2010

Global house prices
Source: IMF
2012 2014

Monetary Policy Review October 2017
However, their fundamentals have improved markedly in recent
years and asset valuations appear much less stretched than
they were, for example, in 2013.
The euro has continued to strengthen in recent months,
buoyed by a sustained economic recovery and marketfriendly election outcomes. Meanwhile, stronger prices of raw
materials have resulted in an outperformance of commodity
currencies, while emerging market currencies have generally
sustained early 2017 gains. Of course, for one currency to
appreciate another must weaken. In recent months, much of
the depreciation pressure has been absorbed by the US dollar,
which has weakened by about 9% so far this year (measured
against a broad basket of currencies).
Global factors supporting
domestic markets
Favourable global conditions have helped limit the impact of
domestic problems on South African financial markets. Despite
a series of shocks over the past six months, the rand has
followed a relatively stable trend, the sovereign yield curve has
shifted lower and the JSE All-Share Index has gained around
6%. Nonetheless, South African assets have not performed as
well as their emerging market counterparts.
In March 2017 the rand reached R12.30 to the US dollar, a
substantial recovery from the January 2016 low-point of almost
R17 to the dollar. It depreciated abruptly again following the
cabinet reshuffle and subsequent credit ratings downgrade,
falling close to R14 to the dollar in early April, but has since
recovered some of these losses. However, the rand’s gain of
nearly 2% versus the US dollar since the start of the year has
fallen short of a 6% rally in the JPMorgan Emerging Markets
Currency Index over the same period.
Over this same six-month span, the South African sovereign
yield curve has shifted lower. The curve has also steepened,
with yields declining by around 80 basis points at the short end
of the curve, but only about 40 basis points at the long end.
These changes are partly explained by lower inflation, with
more movement at the short end because near-term inflation
projections have fallen more than longer-term expectations.
Yet global influences have also been important. South Africa’s
long-term yields have been strongly correlated with their
US counterparts this year, with South African fixed income
securities attracting positive net portfolio inflows totalling
US$3.96 billion in the first eight months of 2017 (according to
the Institute of International Finance).
The JSE All-Share Index has rallied in the third quarter of 2017,
helped in part by the more favourable interest rate environment.
The index nonetheless continues to underperform emerging
market peers (in US dollar terms). Furthermore, much of its
gains are explained by a few large firms with significant foreign
exposure; an adjusted version of the index which excludes
these firms is more consistent with South Africa’s weak
growth outlook.
Ratio
Indices: 2 January 2017 = 100
Jan

Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Emerging market equities versus global counterparts
Source: Bloomberg

MSCI Emerging Markets Index

MSCI World Index

Emerging Markets/World (right-hand scale)


Indices: 2 January 2017 = 100
Jan

Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Currencies
Source: Bloomberg

JPMorgan Emerging Markets Currency Index

US$/ZAR

Per cent
Percentage points
Years

Yield curve

12 April 2017

26 September 2017

Changes (right-hand scale)

Source: Bloomberg
Monetary Policy Review October 2017

Market expectations for
monetary policy
Market expectations for near-term interest rates have fallen
steadily over the past six months. In April, following the
downgrades, investors anticipated further rate increases over
the next two years; three months later, they were pricing in
cuts. This downward shift followed the data, with both inflation
and growth surprising on the downside. The July repo rate
cut prompted short-rate expectations to decline further, with
forward rate agreements (FRAs) fully pricing in a 50 basis
point reduction in the repo rate over the following 12 months
– although about a quarter of this fell away following the
September meeting. The FRA curve also angles back up for
the period 12–24 months ahead, suggesting that investors do
not see scope for a more extended cutting cycle.
Risks
Global asset prices remain vulnerable to the repricing of a variety
of risks. On the global front, a reassessment of the prospective
pace of monetary policy normalisation could easily steepen
yield curves and raise risk premiums on a variety of assets. In
addition, central banks’ balance sheets are likely to shrink over
the coming years, with the Fed leading the process. While the
Fed has signalled its intent to proceed gradually and in a policyneutral way, a process it hopes will be ‘like watching paint
dry’, the consequences of balance sheet reduction for bond
yields remain unknown.8 Finally, while private sector leverage
in advanced economies appears to be under control (with the
exception of a few small economies), equities and corporate
debt look expensive relative to fundamentals – especially in the
US – and could sell off in response to disappointing growth or
corporate profit developments.
Similarly, on the domestic front, asset prices appear vulnerable
to both a repricing of global risk and a deterioration in
South Africa’s credit standing. The exchange rate has been
relatively stable at levels markedly stronger than at the start
of 2016. Local-currency bond yields – especially their inflation
expectation component – do not appear to offer much of a
buffer against potential upside inflation surprises. Furthermore,
the forward-looking price-earnings ratio of the JSE All-Share
Index remains well above long-run norms. The present stability,
therefore, may prove brittle.

‘Transcript of Chair Yellen’s Press Conference’, 14 June 2017, p17,
available at
files/ FOMCpresconf20170614.pdf.
Indices: 2 January 2017 = 100
Jan

Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Bond prices
Source: Bloomberg

JPMorgan Emerging Markets Bond Index

SA 10-year government bond

Indices: 2 January 2017 = 100
Jan

Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Equity prices
Source: Bloomberg

MSCI Emerging Markets Index

JSE All-Share Index

Per cent
Maturities
1x4
2x5
3x6
4x7
Forward rate agreements
Source: Bloomberg

1 April 2017

1 July 2017

31 July 2017

31 August 2017

26 September 2017
5x8
6x9
7x10
8x11
9x12
12x15
15x18
18x21
21x24


Monetary Policy Review October 2017
Real economy: a low
growth trend
Over the past three years, the economy has adjusted away from
unsustainable levels of foreign borrowing towards lower domestic
expenditure and lower imports. However, this rebalancing has
been achieved mainly through slower growth, with adverse
consequences for living standards and fiscal consolidation.
Despite volatility in the quarterly numbers, South Africa’s
underlying growth trend is likely to remain low over the forecast
horizon. Moreover, potential growth has fallen further – a direct
consequence of weak investment. Escaping these circumstances
will require restoring business and household confidence and
implementing reforms that raise potential growth.
Post-crisis shifts in the composition
of GDP
South Africa’s post-crisis economic history divides neatly into
two periods. Between 2010 and 2013, stimulatory fiscal and
monetary policies bolstered demand. This absorbed all the
locally available savings as well as large quantities of foreign
capital. Both consumption and investment expanded as a
share of total output, while net exports contracted as imports
boomed. The growth response proved weak, however, with
the current account and fiscal deficits becoming unsustainably
large relative to output.
In the second period, which should probably be dated from the
May 2013 ‘taper tantrum’, it became clear that foreigners would
not support this scale of borrowing indefinitely. Weakening
capital inflows and currency depreciation prompted policy
course corrections through fiscal consolidation and some
monetary tightening. Shocks (such as the drought and
leadership changes at the Ministry of Finance) also intensified
during this second period, severely depressing confidence
levels. In response, the composition of output shifted
back towards lower shares for domestic consumption and
investment, as well as higher net exports.
The burden of the adjustment was borne more by lower imports,
not higher exports, and more by investment than consumption.
The result was a low-quality, incomplete adjustment: the
economy has not so much changed course as stalled. Given
the current forecasts, the composition of output is likely to shift
further away from investment and imports. This may keep the
current account deficit under control, but a growing share for
investment and exports would be altogether preferable.
Percentage points
Consumption
Investment
Net exports
Changes* in the composition of total output


* These figures are calculated as follows: in 2010 consumption
constituted 79.2% of total output, and by 2013 it was 81.1%,
a 1.9 percentage point increase.
Sources: SARB and Stats SA
Percentage points
Consumption
Investment
Net exports
Breakdown of the compositional change in output


Households

GFCF

Exports

Government

Inventories

Imports
Sources: SARB and Stats SA
Monetary Policy Review October 2017

Box 4 Why is South Africa missing out on the global recovery?
South African output growth usually follows world growth, but the two have diverged in the post-crisis period. This box quantifies the drivers
of South Africa’s underperformance.1 The most important factors have been subdued confidence and lower real commodity prices; had these
variables instead followed their longer-run averages, 2016 domestic growth would have been about 2%. By contrast, fiscal and monetary
policy settings do little to explain the slowdown.
Historically, there has been a relatively strong relationship between global and domestic growth: between 1996 and 2016, a 1% increase in
global growth increased the level of South African output by 0.94%. Of course, various other factors affect local growth. This exercise
considers five such variables: the real effective exchange rate (as a measure of competitiveness), commodity prices, fiscal and monetary policy
settings and consumer confidence (as a proxy for confidence more generally).
It is possible to quantify the discrete impacts using a counterfactual scenario in which these variables are at their longer-run (1996–2013)
averages. In this scenario, global growth is closer to 4%, commodity prices are higher in 2015 and 2016, the rand is stronger and confidence
levels are neutral. Growth is therefore 2.1% in 2016 – as opposed to an actual outcome of 0.3%. Much of the gap is due to declining
confidence: had this variable alone been at average levels, growth would have been 1.4% instead.
This exercise demonstrates the costs of policy uncertainty and the importance of restoring confidence. It also raises another problem. The
model results suggest that ‘normal’ growth is around 2%, which is below the longer-run 3% trend and less than half the National Development
Plan aspiration of 5% or more. Evidently, normalising confidence would not be enough to achieve healthy growth rates. Rather, this would
require a structural reform agenda, including lowering prices in network industries and raising investment towards 25% of GDP.2
1 Based on a forthcoming Economic Note in the South African Reserve Bank Occasional Bulletin of Economic Notes by T Janse van Rensburg and E Visser
titled ‘Decoupling from global growth: is confidence becoming a scarce commodity?’.
2 See for instance D Faulkner, C Loewald and K Makrelov, ‘Achieving higher growth and employment’, South African Reserve Bank Working Paper Series No.
13/03, 2013, available at and F Groepe, ‘Structural reform
to promote economic growth’, 2013, available at:
%20Francois%20Groepe%20at%20the%20UNISA%20Economics%20Seminar.pdf.
Impact on domestic growth over 2014–2016,
with drivers at historical averages
Percentage change

1.70
1.30
0.28
Growth additions with the following
variables at 1996–2013 averages:

What total growth could have been....
1.77
2.35
2.06
Forecast
Percentage change
World growth versus South African growth
Sources: IMF, SARB and Stats SA
South Africa
PPP-weighted
Median
-2
-1

Monetary Policy Review October 2017
South Africa’s growth outlook
The previous edition of the MPR looked forward to a mild
growth rebound over the 2017–2019 period. However, much of
this recovery has been revised away. The original projections
correctly anticipated a recovery in the primary sector, based on
higher commodity prices and the end of the drought. However,
they did not incorporate either the technical recession at the
beginning of the year or the credit ratings downgrades that
followed the March cabinet reshuffle. Given weaker confidence
and a lower starting point, the latest growth forecast is lower
by 0.6 percentage points for 2017 and 0.5 percentage points
for both 2018 and 2019, relative to the March forecasts.
According to the Bureau for Economic Research (BER),
confidence readings for businesses have reached their lowest
levels since the global financial crisis. In the most recent
surveys, 65–70% of respondents expressed dissatisfaction
with business conditions, with more than 50% of respondents
expressing pessimism in every sector surveyed. The South
African Chamber of Commerce and Industry (SACCI) Business
Confidence Index provides starker results still, with confidence
now at its lowest point since 1985. Consumer confidence is
also subdued: the First National Bank/Bureau for Economic
Research (FNB/BER) index is below global financial crisis
levels, and has been since 2015.
The ongoing weak confidence episode is mainly attributable to
political uncertainty. The BER’s manufacturing survey confirms
this point: the share of respondents identifying the ‘general
political climate’ as the biggest constraint to their business has
been rising for several years. The proportion now stands at
87%, making political conditions the single greatest problem
identified in the survey, above both weak demand and skills
constraints. This is also the highest level of concern about the
political environment in the survey’s history.
Expenditure components* of real GDP
Annual percentage change
Components
Actual
SARB forecast


* Note: Previous estimates are in italics
Sources: SARB and Stats SA
Percentage change over four quarters
Index
2001 2003 2005 2007 2009 2011 2013 2015 2017 2019
Business confidence and investment
RMB/BER Business
Confidence Index

Forecast
Sources: RMB/BER, SARB and Stats SA


Real fixed investment
by private business
(right-hand scale)
Percentage change over four quarters
Index

Consumer confidence and private consumption
Sources: FNB/BER and Stats SA
-4
-2


Private consumption
Consumer
confidence
(right-hand scale)
Index
Major constraints to the manufacturing sector in
the third quarter of 2017
Source: BER
Shortage of
unskilled labour
Shortage of
semi-skilled labour
Shortage of
raw materials
Short-term
interest rates
Shortage of
skilled labour
Insufficient
demand
Current political
climate

Monetary Policy Review October 2017

Investment
The historical evidence is clear that investment in South Africa
is highly responsive to uncertainty.9 Accordingly, total real fixed
investment is expected to contract by 0.4% in 2017. Despite
this low base, the recovery further out in the forecast is slight,
with investment expanding by 0.6% in 2018 and 1.1% in 2019
– below the rate of GDP growth. If realised, this would be the
most feeble investment recovery of the past two decades.
The private sector provides the largest portion of total
investment, accounting for around two-thirds of the investment
stock. It is also expected to remain the weakest component of
investment growth over the forecast horizon, contracting for a
third year in 2017 before returning to marginally positive growth
in 2018 and 2019.
Investment by state-owned enterprises (SOEs) is also
depressed. In recent years, SOEs have struggled to spend
their investment budgets, leaving investment forecasts for
this subsector too high. SOEs are now also encountering
financing constraints; for example, Transnet experienced
an undersubscribed bond auction this year. Finally, major
investment projects (such as Eskom’s new power stations)
are nearing completion, and there are no new projects of
comparable size to replace them. Given these considerations,
SOE investment is projected to contract again in 2017, before
expanding slightly in 2018 and 2019 (with 0.5% and 1% growth
in those years respectively).
General government is expected to provide the one
source of positive investment growth for 2017. National
and provincial investment budgets have been protected
from fiscal consolidation measures, leaving scope for
additional investment.
Gross fixed capital formation
Annual percentage change
Actual
SARB forecast


Private business enterprises....

Sources: SARB and Stats SA

See T Ajam and J Aron, ‘Fiscal renaissance in a democratic South
Africa’, Centre for the Study of African Economies Working Paper
Series No. 10, 2007, available at repec.org/
RePEc:csa:wpaper:2007-10; and J W Fedderke, ‘Sustainable
growth in South Africa’, Economic Research Southern Africa
Policy Paper No. 20, November 2010, available at
org/system/files/publications/ policy_papers/pp20.pdf.
Index
1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 2017
Evolution of major constraints to the
manufacturing sector
Insufficient
demand
Source: BER
Current
political
environment

Percentage change over four quarters
Historical downturns in private investment
Sources: SARB and Stats SA
Period

1996Q3–2000Q3

2000Q4–2004Q4

2007Q2–2011Q1

2011Q2–2013Q4

2014Q1–2019Q1

t+10
t+8
t+6
t+4
t+2
t
t-2
t-4
t-6
t-8
t-10


Monetary Policy Review October 2017
The 2016 starting point is also unusually low.10 This should
permit general government investment to expand by 6.0% in
2017 – and the year did in fact begin strongly, with this category
growing 6.3% in the first half of the year compared with the
same period in 2016.
Household consumption
Household consumption growth dipped to 0.8% in 2016, but is
expected to average 1% this year, followed by 1.1% growth in
2018 and 1.4% in 2019. The improvement from 2016 is mainly
due to lower inflation as well as some real wealth gains. The
main story, however, is that consumption growth is likely to
be very weak across the forecast horizon – well below the
post-1994 average of 3.4%. There are several reasons for this
disappointing outlook.
Disposable incomes are being squeezed by tax increases
– both from a higher top tax rate and from bracket creep.
Furthermore, unemployment is likely to increase. The recent
rise in unemployment recorded by Statistics South Africa (Stats
SA) is due to rising labour force participation and not net job
losses; employment has actually risen over the same period.
Yet the private sector typically only employs more people when
GDP growth is roughly 2% or more, while government hiring
remains frozen. The outlook for employment therefore remains
bleak. Finally, household consumption remains constrained by
high debt levels. Lending growth is also suffering from weak
consumer confidence as households defer borrowing for
larger purchases (such as cars and houses).
10 It is not completely clear why government investment slowed
abruptly in 2016, but the single biggest contribution seems to have
come from a contraction in general government grants made to
provinces for building social infrastructure (such as schools).
Percentage change* in employment
Private sector employment and real GDP
Intercept is -1.1 which suggests that if real GDP growth is zero, annual
private sector employment could decline by 1.1%. This suggests annual
real GDP growth must grow by more than 1.8% to generate positive
private sector employment growth.
Sources: SARB and Stats SA
* Year on year
2016 2017

∆ Employment = -1.13 + 0.63 x (∆ real GDP)
Percentage change* in GDP
-6
-4
-2


Monetary Policy Review October 2017

Box 5 Household deleveraging by income groups
Household debt grew rapidly before the global financial crisis,
peaking in 2008 at around 90% of disposable incomes. Since then,
households have been deleveraging. As a result, debt ratios are now
back at 2006 levels of around 70% of incomes – although they
remain well above longer-run averages.
The debt hangover from the boom has been an important contributing
factor to the post-crisis slowdown. Although it is unlikely that
borrowing will resume in the present low-confidence environment, at
some point the credit cycle will turn – with significant consequences
for growth, inflation and the monetary policy transmission mechanism.
Yet our understanding of debt dynamics is based on high-level data,
which provide only a superficial account of deleveraging behaviour.
New research gives us a better sense of which income quintiles are
reducing debts and also improves our understanding of policy
impacts.1
Data from the National Income Dynamics Study (NIDS),2 a survey
that follows individuals over time, show the top two income quintiles
have deleveraged the most, relative to 2008. From 2010/11, some
deleveraging becomes visible among all income groups. Debt
outstanding is, predictably, very different across the income quintiles.
Conditional on having formal debt, the average (median) outstanding
loan for the richest 20% was R118 293 (R32 115) in 2014/15, while
that of the poorest 20% was R7 426 (R2 000) in 2014/15. The debt
ratios of the top and bottom quintiles are nonetheless the highest:
the ratio for the richest 20% was 45% in 2014/15, against 38% for
the poorest. (These levels are not comparable with those described
at the start of this box given the usual problem of surveys not
reaching a representative sample of wealthier people. The trends are
nonetheless similar.)
According to the NIDS data, the share of households with debt has
increased during the post-crisis period. Nonetheless, for indebted
households the average outstanding formal debt has fallen from
R80 460 in 2008 to R54 719 in 2014/15 (in nominal rands). This
implies that more households are borrowing, but they are borrowing
smaller amounts. The mix of more loans but smaller overall debts
means the overall deleveraging trend is not broad-based, but rather
a consequence of reduced big-ticket loans.
This pattern is explained by the disproportionately slow growth of
mortgages in the post-crisis period.3 Because new mortgages have
been relatively scarce, the stock of mortgage debt is still dominated
by pre-crisis loans. Given that the value of these debts is fixed in
nominal terms, whereas incomes have roughly matched inflation,
deleveraging has occurred almost automatically over the ensuing

Based on a forthcoming paper by A Bosch and M Günther
titled ‘Debt deleveraging in post-crisis South Africa’.

Southern Africa Labour and Development Research Unit
(SALDRU), ‘National Income Dynamics Study 2014–2015’, 2017,
available at (accessed 9 June 2017).

This also fits the fact that richer households have deleveraged
most: just 5.5% of all households in the NIDS data hold a
mortgage loan, compared to nearly 25% in the top quintile.
Per cent
Per cent

Household debt and debt service costs
Source: SARB

Debt-service cost to disposable income
(right-hand scale)
Household debt to
disposable income
Per cent
Average formal debt to income ratios
Sources: SALDRU and SARB

Poorest 20%

Second 20%

Middle 20%

Fourth 20%

Richest 20%

2014/15

2010/11

Monetary Policy Review October 2017
decade.4 As a result, the ratio of mortgage debt to incomes has fallen from
nearly 70% in 2008 to under 50% in 2014/15. This suggests a new
upswing of the credit cycle could be led by mortgage lending.
The data also offer insight into the contribution of monetary policy to
deleveraging. In theory, the link is ambiguous. Lower interest rates could
facilitate deleveraging by lowering interest burdens. However, cheap
money should also incentivise demand for credit. By this logic, higher rates
would encourage deleveraging. The data indicate that a higher repurchase
(repo) rate has indeed promoted deleveraging, but only for the upper
income quintiles. This may be because poorer households have less scope
to reallocate income to debt repayment. Alternatively, poorer households
likely borrow at larger spreads over the repo rate, so the incentive effect
could be diluted. These findings are consistent with other studies, which
have found that monetary policy pass-through differs between income
groups.5 The effect on deleveraging is nonetheless small, and much less
significant than the decline in real mortgage debt stocks since the crisis.

The NIDS data show that average incomes have increased
from R104 228 to R120 461 between 2008 and 2014/15.

See, for example, R Ramcharan, A Kermani and M Di Maggio,
‘Monetary policy pass-through: household consumption
and voluntary deleveraging’, Meeting Papers No. 256:
Society for Economic Dynamics, 2015.
Government and fiscal consolidation
National treasury has committed to a fiscal consolidation
programme to stabilise debt levels, which have already doubled
from their pre-crisis starting point. Consolidation has slowed
the growth rate of government spending: having expanded by
an annual average real rate of 4.5% between 2000 and 2007,
and 3.1% between 2010 and 2013, government consumption
has grown by just 1.0% annually since 2014. The SARB’s
forecast indicates narrowly positive growth this year (0.5%)
followed by 1.0% growth in 2018 and 2019.
Although spending has remained on target, revenue collection
has been undermined by low economic growth and weakening
tax compliance, causing repeated misses of deficit targets.
Should revenue continue to grow as it has in the first four months
of the fiscal year, it would be about 4% (more than R40 billion)
lower than Budget 2017 estimates. The fiscal deficit would
therefore likely widen by over 1% of GDP (to around 4.5%, from
a Budget 2017 goal of 3.5% of GDP in 2017/18). This presents
a range of unappealing choices. Larger spending cuts may
further weaken growth, yet the scope for increased taxation
is limited. Furthermore, additional borrowing would take debt
ratios closer to unsustainable levels and divert even more
expenditure into interest payments. The 2017 Medium Term
Budget Policy Statement (MTBPS), which will be presented
by the finance minister on 25 October 2017, will provide more
clarity on the fiscal path in these difficult conditions.
R billions
Government revenue and expenditure (2017/18)
Sources: National Treasury and SARB
Expenditure
Gross revenue


Budget review estimate

Estimate using year-to-date

growth rates
-3.5%
0.3%
Monetary Policy Review October 2017

The external sector and the
current account
Although net exports are detracting slightly from growth this
year – owing to a high 2016 base – their contribution to growth
will be positive again in 2018 and 2019. This is due to exports
growing faster than imports, reflecting a gap between low local
growth and stronger world growth which constrains imports
and favours exports.
The current account deficit has narrowed sharply over the past
few years, from almost 6% of GDP in 2013 to 3.3% in 2016 (and
2.4% in the most recent quarter). Over the forecast period it is
expected to widen somewhat, reaching nearly 4% of GDP by
2019. These trends are mostly explained by the trade balance
of the current account. In recent years, South Africa’s terms
of trade have benefitted from lower oil prices and a rebound
in export commodity prices. Furthermore, weak domestic
investment has curtailed demand for capital imports. Both
these factors reverse course in the forecast: South Africa’s
terms of trade are expected to decline moderately, and positive
investment growth should increase imports of capital goods.
The projected deterioration of the current account deficit is
nonetheless less marked than in previous forecasts, which
once envisioned the deficit reaching 5% again. The change
is chiefly because of a lower oil price trajectory and slower
investment growth over the next two years.
Although the trade balance explains much of the change in the
deficit, the scale of the deficit – at between 3% and 4% of GDP
– continues to be explained by the large services, incomes and
transfers (SIT) deficit. Although this deficit has been fairly stable
for an extended period, its composition has changed over
time. In particular, dividend payments abroad have contracted,
which is probably explained by weaker profitability of locally
listed firms.11 The narrower dividends deficit, however, has
been offset by higher interest payments to foreigners, mainly
because non-residents have purchased large quantities of
government debt. Net foreign interest payments are now at their
highest levels since 1999 – a year of emerging market crises
in which the repo rate averaged almost 15%. As government
continues to run deficits, and capital continues to flow in from
abroad to finance them, interest payments to foreigners are
expected to rise further – contributing to a widening current
account deficit.
Lower potential, larger output gap
Since the release of the previous MPR, potential growth – the
rate of growth possible without accelerating inflation – has
been revised down by an average of 0.3 percentage points for
2017, 2018 and 2019, to just above 1%. This leaves potential
11 South African Reserve Bank, Quarterly Bulletin, ‘Box 3: Dividend
payments to non-residents and real economic growth’, March 2017,
p 42, available at %20and%20
Publications/Attachments/7745/20160331Dividend%20payments%20
to%20non-residents%20and%20real% 20economic %20growth.pdf.
Indices: 2010 = 100

Commodity prices
Sources: SARB and World Bank
Iron ore

Gold
Forecast
Coal
Platinum
Percentage of GDP
-9
-6
-3

Current account

Income account

Trade in goods and services


Transfers

Current account balance
Forecast

Source: SARB
Percentage of GDP

Interest payments

Government

Other

Total

Source: SARB

Monetary Policy Review October 2017
growth below population growth across the forecast horizon.
Disaggregating the potential growth estimate shows the decline
is due to lower capital formation and weaker productivity
growth – two related factors, because new investments would
help narrow the gap with the global productivity frontier. By
contrast, labour force growth has remained relatively constant.
Despite lower potential growth, the output gap has widened
– meaning actual output has been below the economy’s
capacity, even though that capacity is lower. Most of the
output gap comes from 2016 and 2017, with the gap reaching
a trough of nearly -2% of potential GDP this year. It is projected
to narrow gradually over 2018 and 2019, although it remains
negative at the end of the forecast period. As usual, output
gap quantifications must be treated with caution: this is an
unobserved variable and historical estimates of its value have
been revised substantially.
Box 6 The output gap, potential growth and supply
shocks
Output gaps are used to gauge whether or not an economy is
overheating. A positive gap means demand is too strong, causing
inflation to accelerate. By contrast, a negative gap means demand is
too weak, implying a role for stimulus. This makes the output gap a
useful input into forecasting models. Unfortunately, output gap
estimates are notoriously unreliable. This box describes a method for
improving these estimates through a more sensitive treatment of
supply-side shocks.1
An output gap is calculated as the difference between an economy’s
potential level of output and actual production. The South African
Reserve Bank’s published output gap estimates are derived from a
model that does not account for short-term fluctuations in growth
caused by supply shocks.2 This yields a very smooth, slow-moving
measure of potential. As a side effect, this method misdiagnoses
short-term supply shocks as demand phenomena.

See B Botha, F Ruch and R Steinbach, ‘Updating the SARB’s
potential growth model’, SARB Working Paper Series, forthcoming.

See V Anvari, N Ehlers and R Steinbach, ‘A semi-structural approach
to estimate South Africa’s potential output’, South African Reserve
Bank Working Paper Series No. WP/14/08, November 2014.
Per cent
Percentage points
-1

Potential growth and productivity

Capital

Total factor productivity

Labour

Total (right-hand scale)

-1

Sources: SARB and Stats SA
Forecast
Percentage of potential GDP

Output gap with confidence bands

75%

25%

50%

Output gap
-6
-4
-2

Source: SARB
Terms of
trade
decline
Electricity
crisis
Drought
Per cent

2010 2012 2014 2016
Potential growth
Source: SARB
Augmented potential
growth (new)
Smooth
potential
growth (old)

Monetary Policy Review October 2017

The recent drought is a good example. A drought tends to depress
production temporarily. The necessary labour and capital for
productive activity is on hand, but without rainfall, these resources
are unproductive – and there is nothing extra demand can do to
make them productive until water becomes available. However, if the
potential growth measure treats the problem as a demand shortfall it
will encourage two further mistakes. First, it will generate a more
negative output gap that will incorrectly predict lower inflation.
Supply shocks have some disinflationary effects by squeezing
incomes, but these tend to be dominated by scarcity effects that
raise prices. Second, a more negative output gap will in turn justify a
more expansionary policy stance, everything else being equal. Yet
macroeconomic stimulus can only compensate for demand
shortages, not supply-side constraints. Lower interest rates cannot
bring rain.
These problems can be overcome by augmenting the model so that
transitory supply shocks affect potential growth for the duration of
the shock.3 The results show the same declining potential growth
trend following the financial crisis, but there are now shorter-run
variations that align with supply-side disruptions. The new method
captures, for example, the effects of platinum sector strikes,
electricity shortages and the 2015–16 drought. It also narrows
output gaps, both now and historically, including when the economy
was overheating: a more volatile potential growth measure yields a
less volatile output gap. The result is a more accurate input into
policy debates.

For earlier examples of such adjustments, see for instance
P K Clark, ‘The cyclical component of US economic activity’,
Quarterly Journal of Economics 102 (4), 1987, pp 797–814; and
A Alichi, ‘A new methodology for estimating the output gap in the
United States’, IMF Working Paper Series No. WP/15/144, July 2015.
Conclusion
Ultimately, the South African economy has a small demandside problem and a large supply-side problem. With near-zero
growth and a negative output gap, there is some limited scope
for lower interest rates to have positive countercyclical effects
in the short term. In an environment of low confidence and
weak investment, however, there is relatively little that monetary
policy can do to restore growth to historical trends (around
3%) – let alone the National Development Plan goal of 5% or
more. Rather, monetary policy’s chief contribution to growth
is long term and centres on containing borrowing costs by
maintaining credibility. This means inflation expectations and
risk assessments stay low, permitting long-term borrowing at
viable rates. Although this is clearly not a sufficient condition
for sustainable growth, it is necessary.
Percentage of potential GDP

2010 2012 2014 2016
Output gap
Source: SARB
Old method (latest data)
New
method
-3
-2
-1

Monetary Policy Review October 2017
Inflation developments:
below 6% but above 4.5%
Headline inflation moved back within the 3–6% target range in
April 2017, and it is expected to stay within the target for the
rest of the forecast period. Inflation is currently close to the
target midpoint and is projected to remain there into early 2018,
mainly due to positive shocks affecting import prices, electricity
and food. As the effects of these shocks fade, inflation is likely
to accelerate somewhat, reaching 5.3% in 2019.
Lower core inflation
In recent years, there have been substantial gaps between
headline and core inflation. In 2015 the difference was mostly
due to a favourable oil price shock. In 2016 it was a droughtinduced food price shock. This year, however, the gap between
the two has narrowed sharply. Although the SARB targets
headline inflation, in these circumstances the most interesting
information affects core inflation. This section therefore starts
with a discussion of core inflation and concludes with the extra
categories that are added in to headline inflation (food, petrol
and electricity).
Core inflation has been trending down since the beginning
of the year, falling from a peak of 5.9% in December 2016 to
4.6% in August 2017. Core is expected to reach its lowest point
in the final quarter of 2017, at 4.5%, before edging up again in
early 2018 and ultimately stabilising at around 5% in 2019.
The decline in core inflation is overwhelmingly due to goods,
not services, even though services make up two-thirds of the
core category. Services inflation has slowed marginally but
remains well within the upper half of the target range at 5.6% in
August 2017 (against 5.7% in January and a five-year average
of 5.9%). By contrast, core goods inflation has dropped from
5.3% in January 2017 to 2.6% in August.
The deceleration in core goods is closely linked to the
exchange rate, with major contributions from the rand-
sensitive categories of household contents (such as fridges
or televisions) and vehicles. Household contents inflation is
expected to average -0.4% in 2017, down from 1.8% in 2016.
Similarly, vehicles inflation is projected to average 4.7% in
2017, from 7.6% in 2016. It is not surprising that the core goods
category has responded to rand appreciation: these prices
have long tracked the exchange rate. Yet the SARB forecasts
from earlier in the year did not fully anticipate the extent of the
inflation slowdown in these categories. One reason for this is
that the exchange rate assumption was too weak (as discussed
below). There were also some changes in pricing behaviour.
An analysis of the core goods micro-price data from Stats SA
– the individual price details that go into the consumer price
index (CPI) – show slowdowns in both the frequency and scale
of price changes. The most important effect was the scale of
changes, with smaller price increases and larger price cuts than
previously. This was complemented by a reduced frequency of
Percentage points
Per cent
-4
-2

Decomposing core goods inflation into price
increases and decreases

Core goods inflation

Price decreases (right-hand scale)

Price increases (right-hand scale)

-4
-2

Sources: SARB and Stats SA
Per cent

Proportion of core goods prices changing

Proportion of prices

changing

12-month moving

average
Sources: SARB and Stats SA

Percentage change over four quarters

Core inflation and its components
Sources: SARB and Stats SA

Forecast

Core goods (March 2017)

Services (March 2017)

Core inflation (March 2017)

Core goods (September 2017)

Services (September 2017)

Core inflation (September 2017)

3–6% inflation target range
Monetary Policy Review October 2017

changes, meaning more prices were left unchanged. Simply
put, firms eased up on the price accelerator as the exchange
rate appreciated, causing core goods inflation to slow.
For services prices, the forecast surprise is that inflation for this
category has not been higher. Forecasts from earlier in 2017
projected an acceleration in services price inflation, which was
based largely on higher housing costs (combining rentals and
owners’ equivalent rent) as well as insurance – categories with
large weights in the CPI. Housing costs have instead edged down
slightly. This reflects divergence between the provinces. While
housing inflation has accelerated in Gauteng and the Western
Cape, which account for roughly two-thirds of expenditure, this
has been offset by a sharp slowdown in the other provinces,
leaving the aggregate quite stable. As for insurance, warnings
from medical insurance companies of larger cost increases
have not materialised this year, leaving insurance inflation very
close to its longer-run average (around 8%).
A stable exchange rate trend
The exchange rate has followed a relatively flat trend thus far in
2017. There have been episodes of volatility following shocks,
such as the credit ratings downgrades earlier in the year. Yet
these effects have been cushioned by other factors, including
a significantly smaller current account deficit and a weaker US
dollar. Accordingly, the overall trade-weighted exchange rate is
down just 2% for the year to date, and up almost 9% from the
same period a year ago. Given South Africa’s positive inflation
differential with most of its trading partners, the real effective
exchange rate has therefore appreciated by about 4% in 2017
and 13% year on year. Relative to estimates of the equilibrium
real exchange rate, it has been close to fair value through most
of the year, following a period of extreme undervaluation during
late 2015 and much of 2016.
For much of the past two years, the SARB’s assumptions for the
exchange rate have been too depreciated. This chiefly reflects
a methodological problem. The exchange rate assumption
usually starts with the average value prevailing in the quarter
before the MPC meeting. For the rest of the forecast, the
exchange rate adjusts following inflation differentials. South
Africa has higher inflation than most of its peers, so in the
forecast the nominal exchange rate is always depreciating.
This becomes a problem when the rand stabilises and the
real exchange rate begins to appreciate, as it has since early
2016. The problem is exacerbated by volatility, meaning the
forecast assumption can be quite different to the market value
at the time of the meeting. For this reason, MPC statements
have repeatedly warned that the exchange rate implicit in the
forecast is out of line with the current exchange rate. This has
also required a series of upward adjustments to the assumed
real exchange rate path. Although exchange rate forecasts are
invariably inaccurate, the SARB’s forecast are likely to become
less so with the adoption of a different methodology as part of
the Quarterly Projection Model (see Box 1).
Percentage change over four quarters

Owners’ equivalent rent inflation
Sources: SARB and Stats SA

Gauteng and Western Cape

Other provinces

All provinces
Percentage change over four quarters

Actual rental inflation

Gauteng and Western Cape

Other provinces

All provinces
Sources: SARB and Stats SA

Indices: 2010 = 100

Evolution of real effective exchange rate
assumptions
Source: SARB

Jan 2016

Jan 2017

May 2017

Sep 2017

Stronger rand = higher

Sep 2016

Mar 2017

Jul 2017

Actual

Monetary Policy Review October 2017
Offsetting influences on
unit labour costs
Much as exchange rate effects explain recent developments in
core goods prices, so labour costs mostly explain the relative
stability of services inflation. Unlike goods, services are generally
not traded across borders. This means domestic labour costs
are more important for these prices than the exchange rate. To
gauge labour cost pressures, wage gains alone are inadequate
because they do not capture improvements in productivity.
(Higher pay for higher output does not raise costs.) For this
reason, the MPC pays close attention to unit labour costs
(ULC), meaning the overall labour cost per unit of economic
output in the economy. These costs grew 7.8% last year, well
above the upper limit of the inflation target range.12 However,
ULC growth has moderated this year, to 6.1%, and is expected
to fall below 6% for 2018 and 2019 (at 5.6% and 5.8% for these
years respectively).
12 These figures reflect slightly different data to those published in
the Quarterly Bulletin. The salary measure used for forecasting
purposes includes agricultural workers. Normally the two measures
give similar results, although they diverged during 2015 and 2016.
Targeted inflation (September 2017 forecasts)
Percentage change over 12 months, March 2017 forecasts in italics
Weight
Actual
Forecast
Actual
Forecast
2009–16

2017Q1
2017Q2
2017Q3
2017Q4
2018Q1
2018Q2
2018Q3
2018Q4
Targeted inflation.............................................. 100.00

* CPI excluding food, non-alcoholic beverages, fuel and energy
** Combines actual rentals and owners’ equivalent rent, from 2009
Sources: SARB and Stats SA
Per cent

Evolution of unit labour cost forecasts
Source: SARB

Mar 2017

Jul 2017

May 2017

Sep 2017
Monetary Policy Review October 2017

The forecast trajectory for ULCs is shaped by opposing
developments. In the near term, ULCs are decelerating
because wage growth has come down from a spike last
year – even though productivity growth is near zero in the
context of a stagnant economy. Further out in the forecast,
productivity picks up slightly as growth starts moving again
– yet wages recover from their current trough, offsetting
some of the disinflationary effects of productivity gains.
It is, of course, possible to imagine different ULC outcomes.
Historically, wage settlements have not been very sensitive to
unemployment rates or productivity changes. However, wage
moderation may finally take hold with unemployment close to
28% and no productivity growth. It is also possible that inflation
expectations could moderate, reducing wage demands.
The current ULC forecast is nonetheless already low in an
historical perspective.
Inflation expectations
Inflation expectations are crucial drivers of longer-run inflation.
Although popular discussions of inflation are usually about
supply shocks (such as petrol prices or food), these cannot
tell us where inflation will be in the medium term, or why
comparable countries can have markedly different inflation
rates. (For instance, Argentina has inflation of over 20% while
its neighbour, Chile, has inflation of under 3%.) Rather, these
phenomena reflect expectations of inflation, which become
self-fulfilling prophecies when they feed into wage deals and
price setting.13
During the SARB’s 2014–2016 tightening cycle, monetary
policymakers paid close attention to inflation expectations to
help ascertain whether temporary shocks to specific prices
(such as food) would have long-lasting effects on prices
in general. Were expectations coming unmoored? During
the subsequent disinflation phase, the focus has shifted to
lowering expectations.
The first-resort measure of inflation expectations used by the
MPC is the BER’s survey, which incorporates the views of union
leaders, business people and financial analysts. According to
the two most recent surveys, average expectations have fallen
for one, two and five years ahead across all survey groups.
Nonetheless, longer-term expectations remain fairly close to
6%. As is usual for this survey, most of the volatility comes
from analysts, with the average inflation expectation for this
category now down to 5.0% for 2018 and 5.3% for 2019.
By contrast, expectations of trade unionists and business
people in the BER survey are higher – at or just above 6% for
both 2018 and 2019.
Break-even inflation rates provide an alternative, market-based
measure of inflation expectations, based on the gap between
yields for nominal bonds and inflation-protected securities.
13 To reprise the Argentinean example, public school teachers in Buenos
Aires won a 24% pay increase in 2017. See Reuters business news,
‘Argentina 2017 inflation seen at 21.6 percent, above central bank target’,
5 July 2017, available at
inflation/argentina-2017-inflation-seen-at-21-6-percent-above-centralbank-target-idUSKBN19P2K9?il=0 (accesed on 22 August 2017).
Percentage change over four quarters (both scales)
-6
-3

-6
-3

Unit labour cost and its components

Average salaries (left-hand scale)

Productivity (left-hand scale)

Andrew Levy average salaries

Real wages

Unit labour cost
Forecast
2004 2006

Sources: Andrew Levy Employment Publications, SARB and Stats SA
Per cent
Survey-based inflation expectations*

Two years ahead

Five years ahead

Inflation target range

2015 2017

* Total, combining expectations of labour, business and analysts
Source: BER
Per cent

Inflation expectations*

Two years ahead

Current year
* Total, combining expectations of labour, business and analysts
Source: BER


Monetary Policy Review October 2017
They show that expectations have adjusted lower at both
the five- and ten-year horizons: ten-year-ahead expectations
have moved from almost 8% at the start of 2016 towards
6%, while five-year-ahead expectations have fallen below
5.5%, from about 7.5% in 2016. As usual, break-even inflation
rates provide some interpretative challenges. They are not
strictly comparable to expectations surveys, because they
incorporate both a projection for inflation and a risk premium
(if investors believe inflation risks are skewed one way or the
other). Furthermore, they are sensitive to market idiosyncrasies
affecting the underlying instruments from which they are
calculated (mainly because inflation-protected securities
are less frequently traded than ordinary government bonds).
Despite these challenges, these measures do at least show a
clear disinflation trend, consistent with other inflation forecasts
and with inflation outcomes. They do not, however, show
inflation expectations moving much below 6%.
Inflation expectations have not always been at 6%. There
was a period, between 2005 and 2006, when expectations
were concentrated close to the midpoint of the target range.14
However, expectations drifted upwards as the global boom
intensified and commodity prices skyrocketed, peaking well
outside the target range. The global financial crisis brought
expectations down again, but only as far as the top of the
target range, and they have been in that vicinity ever since. This
is undesirable. Lower expectations would help reduce inflation
and interest rates. Furthermore, having expectations close to
6% leaves little room for absorbing shocks. Accordingly, the
MPC’s stated preference is for expectations to be anchored
closer to the midpoint of the 3–6% target range.
The available data support two conclusions relevant to the
problem of lowering expectations. First, inflation expectations
are largely backward-looking: many respondents will need
to see lower inflation before changing their views. As such,
we should expect lower inflation to moderate expectations.
Second, longer-term expectations have been nearly immune to
short-lived disinflations. For instance, inflation was close to the
midpoint of the target range in 2015 because of the collapse
in world oil prices. Inflation was similarly subdued through
much of 2010/11, with oil prices again low and the exchange
rate near R7 to the US dollar. Although surveyed expectations
for the current year fell during these episodes, longer-term
expectations remained stable near 6%. This suggests it will
take both careful communication, and a longer period of lower
inflation, to moderate longer-term inflation expectations.
Slowing food price inflation
Last year’s drought pushed food and non-alcoholic beverages
(NAB) inflation sharply higher, to 10.6% in 2016 from 5.1% the
year before. Food and NAB inflation is forecast to average 7.3%
in 2017 and 5.2% in 2018 as the drought effects dissipate,
14 See S Hassan and S Redford, ‘Dispersion of inflation expectations’,
South African Reserve Bank Occasional Bulletin of Economic Notes,
June 2017, available at
and%20Publications/Attachments/7851/OBEN%201702.pdf.
Per cent

Break-even inflation rates

Five year

Ten year
Source: Bloomberg

Per cent
Oils and
fats
Vegetables
Meat
Fruit
Bread and
cereals
-5

Main food drivers

2009–2016 average

Sources: SARB and Stats SA
Monetary Policy Review October 2017

contributing 1.3 and 0.9 percentage points respectively to
headline inflation compared with 1.6% in 2016. By 2019,
conditions are expected to normalise, leaving food and NAB
inflation at 5.6%, in line with long-term averages.
The food price forecast has fluctuated over the course of the
year. Higher poultry prices prompted an upward revision of
the food price trajectory between the March and May MPC
meetings – but food prices were marked back down again for
the July meeting due to downward movements in other food
categories (mainly dairy, vegetables, and bread and cereals).
In September the forecast was adjusted slightly higher again,
once again due to higher meat inflation. Despite this volatility,
the underlying food price dynamic remains about the same.
The categories where harvests were affected by drought
in 2016 are now disinflating, led by maize with a record
16.7 million tonne commercial harvest expected in 2016/17
(according to the Crop Estimates Committee). Yet meat prices
are partly offsetting this effect.
Meat prices rose more rapidly than anticipated in the second
half of 2016 and the first half of 2017, owing mainly to surging
poultry and beef prices. Meat price inflation is now forecast to
average 12.9% this year, well above the longer-term average.
Poultry prices have been affected by avian influenza (bird flu)
outbreaks, both abroad and locally. Meanwhile, domestic
brining regulations have also lifted chicken prices. The other
important driver of higher meat prices is herd-rebuilding
effects, reflected in lower cattle slaughter figures. As these
shocks abate, poultry inflation is forecast to ease from 14.9% in
2017 to 7.6% in 2018, while beef prices moderate from 13.8%
to 7.7%.
Consumer food price inflation (September 2017 forecasts)
Percentage change over 12 months, March 2017 forecasts in italics
Actual
Forecast
Actual
SARB forecast
Weight
2009–16

2017Q1
2017Q2
2017Q3
2017Q4
2018Q1
2018Q2
2018Q3
2018Q4


Sources: SARB and Stats SA
Percentage points
Percentage change over four quarters
-2

Food inflation contributions

Bread and cereals

Milk and cheese

Vegetables

Food (right-hand scale)
Sources: SARB and Stats SA

Meat

NAB

Other foods
Forecast

-2

Monetary Policy Review October 2017
Fuel price developments
The Brent crude oil benchmark has been stuck below US$60
per barrel for most of the past three years, and has been
closer to US$50 for much of 2017. Production cuts by the
Organization of the Petroleum Exporting Countries (OPEC) and
Russia helped lift prices back towards US$60 in the early parts
of this year. Yet these cuts were ultimately too small to maintain
prices at those levels, in part because they did not constrain
OPEC members that had previously suffered production
disruptions (Nigeria and Libya), and in part because OPEC’s
monopoly power has been weakened by new North American
producers. The long-term outlook for oil demand is also
unfavourable, given improvements in electric car technology
and regulatory shifts in favour of cleaner technologies. (Both
France and the UK, for example, have banned the sale of new
petrol and diesel cars from 2040 onwards.) For these reasons,
it is very unlikely that oil prices will rise to the triple-digit levels
last seen in 2014. They are nonetheless likely to remain volatile
within a range of roughly US$50–US$60. Indeed, at the time of
the September MPC meeting they were back close to US$60,
apparently due to evidence of stronger global demand as well
as potential supply disruptions related to an independence
referendum in Iraqi Kurdistan.
The oil price assumptions used in the forecast tend to follow
pricing in futures markets as well as private sector forecasts.
The latest oil price assumption is US$52 per barrel for 2017,
US$55 for 2018 and US$56 for 2019. This is somewhat below
the March 2017 assumptions, which were US$57 per barrel for
2017, US$60 for 2018 and US$62 for 2019.
Lower oil prices have, in turn, fed into domestic fuel price
forecasts. Rand-denominated Brent crude oil prices are
now expected to increase by 7.3% in 2017 and 2018,
before moderating to 5.2% in 2019 – well below the March
2017 forecasts of 20.7%, 9.2% and 7.0% for these years
respectively. Accordingly, fuel price inflation is now forecast
to average 6.9% in 2017, 6.4% in 2018 and 5.6% in 2019. As
before, the full benefits of lower international oil prices are not
reaching consumers because of domestic taxes and margins,
which have risen by around 10% annually since 2003 and are
expected to maintain roughly these growth rates.
Electricity inflation: less now and
more later
Electricity inflation has fallen to 2.1% – the lowest rate of
electricity prices inflation since 2006. However, the slowdown
will almost certainly be short-lived. Electricity prices have
decelerated because of a decision by the National Energy
Regulator of South Africa (NERSA) affecting the Regulatory
Clearing Account (an account used to align electricity prices
with production costs). NERSA’s decision was set aside by the
High Court, but it has since been upheld by the Appeals Court,
clearing the way for a much larger electricity price increase in
Rand per litre

Fuel price and its components*
* Petrol price prior to January 2017, combined petrol and diesel price
thereafter
** Movements of the Brent crude oil price (in rand) in August 2017 contributed
to the fuel price rise in September 2017
Sources: Department of Energy and SARB

Fuel
Domestic taxes and margins
Forecast
Brent crude oil (lagged)**
Refinery margin and other costs
Monetary Policy Review October 2017

2018/19. The current SARB assumption is for an 8% increase,
but Eskom has requested a double-digit adjustment, and there
are risks the 8% number may prove to be too low.
For this reason, the SARB has also modelled a scenario in
which electricity prices rise 20% for one year, starting in July
2018. The result is an extra 0.2 percentage points on inflation
for 2018 and 0.3 percentage points for 2019, counting both
the direct and indirect effects of costlier electricity. In terms of
the Taylor rule in the Quarterly Projection Model (described in
Box 3), this would prompt an interest rate response, reversing
the July MPC rate cut.
Conclusion
The outlook for inflation has improved steadily over the course
of 2017. Headline inflation has fallen back below 6% and is
currently close to the midpoint of the 3–6% target range. The
drop in inflation reflects declines across the major inflation
categories: food, petrol, electricity and core. Yet the drivers of
lower inflation – especially the exchange rate and the end of
the drought – are likely to be temporary. Furthermore, services
inflation has been quite stable and inflation expectations
remain close to the top of the target range, especially for the
longer-term outlook. Accordingly, inflation is projected to pick
up again next year, ultimately stabilising at around 5.3% for the
remainder of the forecast period.
Box 7 Comparing the SARB’s forecasts with those of other central banks
The South African Reserve Bank (SARB) regularly evaluates the accuracy of its forecasts and reports the results in the Monetary Policy Review
(MPR). For instance, the April 2017 MPR compared the SARB’s inflation forecasts with those of private sector analysts. The October 2016 MPR
assessed the reliability of the core inflation forecasts. This box takes a different approach. How good are the SARB’s forecasts of South African
inflation compared with other central banks’ forecasts of their own national inflation rates?
We test the forecasts for both overall accuracy and bias. The data are inflation forecasts1 for 2011 to 2016, from 12 emerging market inflationtargeting central banks.2 We use January forecasts for the current-year, one-year-ahead and two year-ahead forecasts.3
To measure accuracy, we use root mean square errors (RMSE), with a low (high) score indicating a small (large) average error over the sample
period. South Africa ranks second for the current-year forecast and first for the other forecast horizons. Although this result is encouraging,
South African inflation has also been less volatile than that of most other countries, with a standard deviation under 1 percentage point versus,
for example, 1.5 percentage points in Brazil and more than 3 percentage points in Russia. It is, of course, easier to forecast a more stable
variable.
To evaluate the bias of forecasts, we use two measures: an average forecast error and a tracking signal. The first measure is the standard test of
bias. However, it can be misleading when used to compare forecast performance across countries with very different inflation rates. It also allows
a few large errors to cancel out many smaller ones. The tracking signal remedies these shortcomings by counting the direction of misses. For
instance, if a central bank forecast is too high four times, and too low twice, it will get a score of two. Zero – the best score – indicates either that
the forecasts were perfect or that misses were evenly scattered above and below the actual outcomes.
In terms of average errors, the SARB’s scores are the best over all three time horizons. The tracking signal results are not quite as good: the
SARB ranks near the middle of our sample. However, the bias changes over the different forecast horizons, which suggests the forecasts do not
systematically lean one way or the other. Furthermore, in comparative perspective, the scale of the SARB’s biases is small for both measures.
Our sample indicates other emerging markets where biases have been much more marked, which is consistent with large inflation overshoots
in these specific cases.

Inflation forecasts are for calendar years, except for Russia and Turkey. Both central banks set their inflation targets as a year-end target
and forecast year-end inflation.

Mexico, Colombia and Indonesia are obvious omissions; they were excluded because they do not publish model-based inflation forecasts.
India was also excluded as the central bank only adopted inflation targeting in February 2015.

Where two-year-ahead forecasts were not available in January, we used the earliest available published forecast.
Percentage change over 12 months

Electricity inflation
Source: Stats SA
-5

Monetary Policy Review October 2017
Current year
RMSE rankings
Forecast accuracy and bias measures
Russia
Turkey
Brazil
Peru
South Korea
Median
Poland
Chile
Thailand
Hungary
South Africa
Czech Republic

One year ahead
Russia
Turkey
Brazil
Hungary
Poland
Median
Thailand
South Korea
Peru
Czech Republic
Chile
South Africa

Two years ahead
Current year
One year ahead
Two years ahead
Current year
One year ahead
* Two-years-ahead forecasts are not available for the Czech Republic, Peru, South Korea and Thailand
Sources: Bloomberg, SARB and other central banks
Two years ahead

Thailand*
South Korea*
Peru*
Czech Republic*
Russia
Turkey
Hungary
Median
Brazil
Poland
Chile
South Africa
Tracking signal
Average error
Turkey
Russia
Brazil
Peru
South Korea
Thailand
Hungary
Poland
Czech Republic
Median
Chile
South Africa
-3
-2
-1

Russia
Turkey
Brazil
Peru
South Korea
Thailand
Hungary
Poland
Czech Republic
Chile
Median
South Africa
-3
-2
-1


Thailand*
South Korea*
Peru*
Czech Republic*
Turkey
Russia
Brazil
Poland
Hungary
Median
Chile
South Africa
Peru
Brazil
Turkey
Thailand
South Korea
Poland
Hungary
Chile
Median
South Africa
Czech Republic
Russia
-6
-4
-2

Turkey
Peru
Brazil
South Korea
Thailand
Median
South Africa
Russia
Poland
Hungary
Czech Republic
Chile
-6
-4
-2

-6
-4
-2

Thailand*
South Korea*
Peru*
Czech Republic*
Turkey
Russia
Brazil
Median
Chile
South Africa
Poland
Hungary
Under-forecast
Under-forecast
Under-forecast
Under-forecast
Under-forecast
Under-forecast
Over-forecast
Over-forecast
Over-forecast
Over-forecast
Over-forecast
Over-forecast
Monetary Policy Review October 2017

Summary
The hiking cycle of 2014–2016 achieved its desired effects,
helping guide inflation back within the target range and
keeping it there. With hindsight, it is clear the main transmission
mechanism was the exchange rate, aided by more marginal
contributions from the negative output gap and inflation
expectations. By raising the repo rate from 5% to 7%, the MPC
concluded an extended period of unusually low, often negative,
real rates. This reinstated a clear positive gap with interest rates
in the major advanced economies, reviving capital inflows and
appreciating the exchange rate.
Of course, monetary policy was not solely responsible for
these developments. The global context was important.
In particular, stimulus in China eased fears of a rapid and
potentially uncontrolled slowdown in that economy, which
calmed financial markets while boosting global growth and
commodity prices. Furthermore, advanced economy monetary
policies proved looser than previously anticipated, chiefly due
to downside inflation surprises, which supported capital flows
to emerging markets. Falling oil prices also helped narrow
South Africa’s current account, reducing external borrowing
requirements. Combined, these circumstances have helped
lower inflation to below 5% in the third quarter of 2017 – a faster
and more complete return to target than initially anticipated.
South Africa’s recent experience of policy tightening and
disinflation echoes that of peer emerging markets, including
major players such as Brazil, Russia and India. Furthermore, in
the counterfactual cases where real rates did not get to positive
levels, exchange rates have weakened further and inflation has
accelerated. A prominent example is Turkey, where inflation is
now over 10%, versus a target of 5%. These emerging market
experiences testify to the power of central banks to lower
inflation if they so choose, and the costs of neglecting this role.
By contrast, the growth implications of monetary tightening
during this period have almost certainly been small. South
Africa’s interest rate adjustment was relatively limited, and the
relationship between interest rates and credit extension has
in any case been unusually weak in the post-crisis period.
Furthermore, the rand has not appreciated beyond estimates
of fair value.
Nonetheless, domestic growth has slowed almost to a
standstill over the past two years and is unlikely to recover
significantly over the two years of the forecast, making this one
of the worst growth periods in South Africa’s history. (If the
forecasts prove correct, the 2010s will be the second-worst
growth decade in South Africa’s post-war economic history.)
The outstanding problem at present is depressed confidence.
As a result, investment is contracting and potential growth is
therefore very low.
Stimulus only works if it elicits a positive response from the rest
of the economy, creating a virtuous circle of stronger investment
and stronger demand. With confidence held down by factors
Percentage points
Per cent
2001 2003
2005 2007 2009

Real interest rate differential
Sources: IMF and SARB

South Africa

G3

Differential (right-hand scale)
-2

-2

NEER (percentage change)*
Emerging market policy rates and exchange rates

* Average 2017 year-to-date change from 2016 average
** Average 2016 nominal policy rate less CPI 2017 year-to-date
Sources: BIS and Bloomberg
Real policy rate (per cent)**
Turkey
Malaysia
Mexico
Hungary
Czech Republic
Thailand
Peru
Poland
Chile Indonesia
Colombia
South Africa
India
Russia
Brazil
China
-6
-3

-18
-12
-6

Percentage change

South African real GDP growth rates

Sources: SARB and Stats SA

Monetary Policy Review October 2017
other than demand, investment is unlikely to follow. This means
the benefits of stimulus would be largely temporary, while the
costs would be more permanent.
Nonetheless, growth outcomes have been very low over the
past two years or so, below even revised estimates of potential
growth. This leaves some scope for countercyclical policy in
the short term. Monetary policy’s chief contribution to growth,
however, is keeping inflation low and stable, which facilitates
long-term planning and moderates borrowing costs. For this
reason, near-term demand support must be balanced by
policies to reduce long-term inflation expectations, thereby
lowering borrowing costs. Inflation targeting provides an
effective framework for reconciling these short- and long-term
goals, ultimately delivering growth in line with potential as well
as price stability.
Monetary Policy Review October 2017

Statement of the Monetary Policy Committee
25 May 2017
Issued by Lesetja Kganyago, Governor of the South African Reserve Bank,
at a meeting of the Monetary Policy Committee in Pretoria
Headline inflation has now returned to within the target range
as expected, with outcomes in March and April surprising
on the downside. While the inflation outlook has improved
over the near term, the longer-term forecast trajectory is
unchanged and uncomfortably close to the upper end of
the target range. The rand exchange rate and domestic
bond yields benefitted from increased global capital inflows
to emerging markets which largely offset the impact of the
sovereign credit ratings downgrade. With further ratings
decisions imminent, risks remain for a further depreciation
against the backdrop of continued global and domestic
political uncertainty.
Domestic economic growth prospects have deteriorated,
as the impact of the ratings downgrade is expected to
weigh on domestic investment and consumer sentiment
over the forecast period. The output gap is estimated to
have widened and consumer demand has weakened.
However, the trajectory of the growth forecast is still positive
and the growth rate for this year is expected to exceed that
recorded in 2016.
The year-on-year inflation rate as measured by the consumer
price index (CPI) for all urban areas moderated to 6.1% and
5.3% in March and April respectively. Food price inflation
was the main contributor to the downside surprise in April
when it measured 6.6%. The contribution of the category
of food and non-alcoholic beverages to the overall inflation
outcome declined from 1.5 percentage points in March to
1.1 percentage points in April. The South African Reserve
Bank’s (SARB) measure of core inflation, which excludes
food, fuel and electricity, measured 4.8% in April, down from
4.9% in March.
Producer price inflation for final manufactured goods also
surprised on the downside at 4.6% in April compared with
5.2% in March. The further moderation in food prices was
also reflected in the producer price index with the category
of food products, beverages and tobacco products
decelerating for the sixth consecutive month to 6.4%.
The inflation forecast of the SARB has improved over the
near term, but is unchanged in the outer quarters. In line
with the previous forecast, headline consumer price inflation
is expected to remain within the range for the rest of the
forecast period. Inflation is expected to average 5.7% this
year compared with 5.9% previously, while the forecast for
2018 has moderated by 0.1 percentage point to 5.3%. The
forecast average for 2019 is unchanged at 5.5%.
The improvement is driven by downward revisions to
international oil price and domestic electricity tariff
assumptions. In the latter case, a tariff increase of 4.0%
with effect from July 2017 is assumed – down from 8.0%.
These revisions have been offset to some extent by a
less appreciated exchange rate assumption and a slower
decline in food price inflation. A continued moderation of
food prices is expected over the medium term given the
favourable agricultural outlook and significant upward
revisions to the maize crop estimates. Food price inflation
is expected to average 7.7% and 5.4% in 2017 and 2018
respectively, compared with 7.4% and 5.2% previously, and
to remain unchanged at 5.5% in 2019.
The forecast for core inflation in 2017 is 0.4 percentage
points lower at 5.0%, partly due to the lower starting point
of 0.2 percentage points following the sizeable downside
surprise in March. The forecast for 2018 declined by
0.1 percentage points to 5.1%, and is unchanged at
5.3% in 2019.
Market-based inflation expectations have remained largely
unchanged since the previous meeting of the MPC, with the
median forecasts in the latest Reuters Econometer survey
similar to those of the SARB. The median expectation for
2017 declined marginally to 5.7%, and is unchanged at 5.5%
and 5.4% for the next two years respectively. Expectations
implicit in the break-even inflation rates in the bond market
have also moderated since the previous meeting. Breakeven inflation rates for shorter-dated maturities are below
6% but higher than this level for longer-dated maturities.
The global growth outlook continues to show signs of
sustained recovery amid rising world trade volumes.
Nevertheless, the trend growth rate is expected to be
lower than that experienced before the global financial
crisis. The current recovery is characterised by downward
revisions to potential output growth in numerous countries,
and generally low levels of productivity and wage growth.
Despite a weak first quarter, growth in the United States
(US) is expected to average above 2.0% this year, although
further policy uncertainty could undermine investor and
consumer confidence. Growth rates in the euro area and
Japan are expected to be sustained at around 2016 levels,
supported by accommodative monetary policies.
The outlook for emerging markets is also generally positive.
Concerns about Chinese growth have dissipated somewhat
following policy intervention, but high leverage in the financial
sector remains a risk. While Russia has emerged from
recession, the expected recovery in Brazil may be undermined
by current political uncertainty. The outlook for commodity
producers may be tempered by recent weaker commodity
price trends, particularly those of iron ore and coal.

Monetary Policy Review October 2017
Global inflation remains relatively benign, although country
experiences differ. Inflation is below target in most of the
advanced economies, apart from the United Kingdom,
and the risk of deflation is low, except in Japan. Where
high inflation rates are being experienced in a number of
emerging markets, these are generally driven by exchange
rate shocks rather than underlying global price pressures.
Monetary policies are also likely to remain divergent. The US
Federal Reserve (Fed) is expected to maintain its moderate
pace of tightening, dependent to some degree on the
size and nature of possible fiscal reforms. Policy rates are
expected to remain low in most other advanced economies,
but a reduction in quantitative easing is possible in the
near future in the euro area. In general, emerging market
economies have displayed a loosening bias, particularly
in those countries where previous policy tightening had
resulted in improved inflation prospects. The high yield
differentials of emerging markets have persisted, sustaining
capital flows to these economies.
At the time of the previous meeting of the MPC, the rand
was trading at around R13.00 against the US dollar. It
then depreciated following the domestic cabinet reshuffle
and the consequent sovereign credit ratings downgrades
by two ratings agencies. Having reached a weak point
of almost R14.00 against the US dollar in April, the rand
subsequently recovered some of these losses in line with
improved sentiment towards emerging markets in general.
Some of these gains were reversed by spillover effects of
recent political uncertainty in Brazil. Since the previous MPC
meeting, the rand has appreciated by 0.4% against the US
dollar and depreciated by 1.6% on a trade-weighted basis.
At current levels, the rand is still more appreciated relative to
rates prevailing at this time last year.
Despite the recent weakening, the rand has been supported
by a more favourable current account outlook following a
significant narrowing of the deficit in the final quarter of last
year. A further positive trade balance was recorded in the
first quarter of this year, but a moderately wider current
account deficit is expected over the forecast period, due in
part to a recent deterioration in the terms of trade.
Non-residents remained net buyers of domestic government
bonds in April and May to date, to the value of R23.2 billion,
despite the recent ratings downgrades. This may change
should further downgrades occur, particularly with respect
to domestic currency ratings. The rand therefore remains
vulnerable to this prospect as well as to changes in global
risk sentiment towards emerging markets.
The domestic growth outlook has deteriorated amid weak
business and consumer confidence. The SARB’s forecast
for GDP growth has been revised down for the entire
forecast period, by 0.2 percentage points for 2017 and
2018, and by 0.3 percentage points for 2019. Annual growth
rates of 1.0%, 1.5% and 1.7% for the forecast years are
now expected. This downward revision is due in part to the
expected impact of the sovereign credit ratings downgrade
on domestic private sector gross fixed capital formation in
particular. The downgrade is also likely to weigh on public
sector investment through higher funding costs and more
difficult access to funding.
At the sectoral level, a strong near-term improvement is
expected in the agricultural sector, and mining output has
also rebounded. By contrast, the manufacturing sector
outlook remains constrained, with a third consecutive
quarterly contraction expected in the first quarter of this
year. In line with this, the latest Absa Purchasing Managers’
Index showed a sharp decline. Growth in the trade sector
also appears to have moderated somewhat.
A slower but positive pace of household consumption
expenditure growth is forecast for this year. Real retail and
wholesale trade sales contracted in the first quarter of this
year. While domestic sales of passenger motor vehicles
improved, the outlook for the sector remains subdued.
Factors such as low consumer confidence, higher tax
burdens, the absence of significant wealth effects and
stagnant employment growth have contributed to these
weaker consumption trends.
In addition to these factors, credit extension to the household
sector in particular remains weak, and is reflected in further
household deleveraging. Although credit extension to the
corporate sector is still relatively robust, the downward
growth trend has persisted. There may, however, be
some relief to consumers from moderating inflation, while
increases in real disposable income over the forecast period
are also expected to provide some support to consumption,
but to a lesser extent than previously.
Nominal salary and wage increases have continued to show
signs of moderation but are still at levels that contribute to
the persistence of inflation at higher levels. While continued
moderation of nominal unit labour costs are expected over
most of the forecast period, the trajectory has been revised
slightly upwards, largely due to the weaker economic growth
projections.
International oil prices have firmed since the previous MPC
meeting, having declined to levels below US$50 per barrel
at one stage. The recovery was a response to indications
that the Organization of the Petroleum Exporting Countries
(OPEC) agreement to curtail output would be extended for
a further six months. However, the fragility of this agreement
and the increase in shale production in the US is expected
to cap increases going forward. The international oil price
assumption has been revised down by US$2 per barrel
for each forecast year, but the moderate upward trend
has been maintained. Domestic petrol prices increased by
around 50 cents per litre in May due to the weaker exchange
Monetary Policy Review October 2017

rate and higher international product prices. The current
over-recovery on the petrol price indicates that a reduction
of around 20 cents per litre is likely in June, mainly due to
international price movements.
The short-term inflation outlook has improved further since
the previous meeting of the MPC. Headline inflation in April
was lower than expected, largely related to the pace of food
disinflation. The MPC notes, however, that there have been
broad-based downside surprises in core inflation as well.
The current forecast does not incorporate the most recent
outcomes, and further downside surprises in the coming
months could have an impact on the starting point of the
forecast and lower the entire trajectory. However, in the
absence of such revisions, the MPC remains concerned
about the persistence of the longer-term forecast trend at
elevated levels within the target range. This gives very little
scope to absorb the impact of possible adverse shocks.
The rand remains a key upside risk to the forecast. The rand
has, however, been surprisingly resilient in the face of recent
domestic developments. This is partly due to offsetting
factors, particularly positive sentiment towards emerging
markets and the improved current account balance. The
current level of the exchange rate, at below R13.00 against
the US dollar, is slightly stronger than at the time of the
previous MPC meeting and stronger than that implicit in the
starting point for the real exchange rate assumption.
The outlook for the rand, and therefore the risks to the
inflation outlook, will be highly sensitive to unfolding
domestic political uncertainty as well as decisions by the
credit ratings agencies. The rand could weaken significantly
in the event of a worst-case ratings downgrade scenario
that could result in South African government bonds falling
out of the global bond indices.
A downside risk may come from electricity tariffs. The
increases from July may be lower than the 4.0% now
assumed, given the 1.8% guideline for municipalities
published by the National Energy Regulator of South Africa
(NERSA). However, there is a great deal of uncertainty
with regard to this assumption for next year, when a new
application from Eskom is likely. Currently, an 8.0% increase
is assumed from July next year.
The MPC assesses the risks to the inflation outlook to be
more or less balanced. Domestic demand pressures remain
subdued and, given the continued negative consumer and
business sentiment, the risks to the growth outlook are
assessed to be on the downside.
In light of these developments, the MPC has decided to keep
the repurchase (repo) rate unchanged at 7.0% per annum.
Five members preferred an unchanged stance while one
member preferred a 25 basis point reduction.
The MPC remains of the view that the current level of the
repo rate is appropriate for now and that we are likely at
the end of the tightening cycle. A reduction in rates would
be possible should inflation continue to surprise on the
downside and should the forecast over the policy horizon
be sustainably within the target range. However, in the
current environment of high levels of uncertainty, the risks
to the outlook could easily deteriorate and derail the current
favourable assessment.

Monetary Policy Review October 2017
Summary of assumptions: Monetary Policy Committee
meeting on 25 May 2017*
1. Foreign sector assumptions
Percentage changes (unless otherwise indicated)
Actual
Forecast

1. Real GDP growth in South Africa’s major trading-partner countries...


2. Domestic sector assumptions
Percentage changes (unless otherwise indicated)
Actual
Forecast


The figures in brackets represent the previous assumptions of the Monetary Policy Committee.
* For an explanation of foreign sector assumptions and domestic sector assumptions, see pages 51 and 52.
Monetary Policy Review October 2017

* Figures below the forecast in parentheses represents the previous MPC forecast
Per cent
Actual
Forecast


(-3.2)
(-3.9)
(-4.0)
The figures in brackets represent the previous forecasts of the Monetary Policy Committee.
* Figures below the forecast in parentheses represents the previous MPC forecast
Year-on-year percentage change
Actual
Forecast


The figures in brackets represent the previous forecasts of the Monetary Policy Committee.
Selected forecast results: Monetary Policy Committee meeting on 25 May 2017

Monetary Policy Review October 2017
Statement of the Monetary Policy Committee
20 July 2017
Issued by Lesetja Kganyago, Governor of the South African Reserve Bank,
at a meeting of the Monetary Policy Committee in Pretoria
Since the previous meeting of the Monetary Policy
Committee (MPC), the inflation outlook has improved.
Food price inflation has moderated faster than expected,
domestic demand pressures remain subdued, and
international oil prices have declined. Despite a degree of
volatility, the rand exchange rate has been relatively resilient
in the face of expected monetary policy tightening in some
advanced economies as well as domestic political risks and
uncertainties. Risks to the inflation outlook still remain.
At the same time, domestic growth prospects have
deteriorated further following the surprise contraction of
gross domestic product (GDP) in the first quarter of 2017.
The economy has now recorded two successive quarters
of negative growth, and although a near-term improvement
is expected, the outlook remains challenging. A number of
sentiment indicators and data points have reached levels
last seen during the 2009 recession, at the height of the
global financial crisis.
The year-on-year inflation rate as measured by the
consumer price index (CPI) for all urban areas measured
5.4% and 5.1% in May and June respectively, in line with the
South African Reserve Bank’s (SARB) short-term forecast.
Food and non-alcoholic beverage inflation measured 6.9%
in both months, with the contribution to the overall inflation
outcome unchanged at 1.2 percentage points. Meat prices
continued to accelerate, and at 13.0% contributed to the
downside stickiness of food price inflation. The SARB’s
measure of core inflation, which excludes food, fuel and
electricity, measured 4.8% in both months.
Producer price inflation for final manufactured goods
measured 4.6% in April and 4.8% in May. The further
moderation in food prices was reflected in the producer
price index with the category of food products, beverages
and tobacco products decelerating for the seventh
consecutive month to 5.8%. The divergent trends between
the subcategories of ‘products of crops and horticulture’
and ‘live animals’ persisted, with year-on-year changes of
-24.4% and 21.4% respectively.
The SARB’s forecast for headline CPI inflation has shown
a marked improvement since the previous MPC meeting.
The annual average forecast has been revised down by
0.4 percentage points for both 2017 and 2018, and by
0.3 percentage points for 2019 to 5.3%, 4.9% and 5.2%
respectively. A lower turning point of 4.6% is expected in
the first quarter of 2018 (previously 5.1%) and an average of
5.2% is forecast for the final quarter of 2019.
The main drivers of the improved forecast were the lower
starting point; revised assumptions regarding international
oil prices, domestic electricity tariffs and the real effective
exchange rate; and a wider output gap. These assumptions
are set out in the annexure to this statement. Food price
inflation is also expected to be more subdued due to a lower
starting point and more favourable domestic crop estimates.
Despite a persistent upward trend in meat price inflation, the
forecast for food price inflation has been revised down from
7.7% to 7.3% for this year, and from 5.4% to 5.1% in 2018.
The forecast for 2019 is unchanged at 5.5%.
The improvement is also evident in the core inflation
outlook, with average forecasts of 4.8% for 2017 and 2018,
and 4.9% for 2019. This compares with previous forecasts
of 5.0%, 5.1% and 5.3% for these years. This improvement
is driven in part by lower unit labour costs, in addition to the
exchange rate and output gap developments.
Inflation expectations as reflected in the survey conducted
by the Bureau for Economic Research show a marginal
improvement, with average expectations slightly below 6%
in all three years. The decline was most marked among
analysts, particularly over the first two survey years, and
to a lesser extent among labour unionists. Both these
categories of respondents expect inflation to be within the
target range over the forecast period. The expectations of
business respondents are largely unchanged and remain
above 6% for all three years. By contrast, average five-year
expectations of all groups edged up from 5.7% to 5.9%, and
ranged between 5.5% for analysts and 6.3% for business
respondents.
Median inflation expectations of market analysts improved
over the near term. According to the Reuters Econometer
survey conducted in July, expected inflation declined by
0.2 percentage points to 5.5% in 2017 and to 5.3% in 2018
compared with the May survey. However, the longer-term
trend is reversed with an expectation of 5.5% in 2019.
Expectations implicit in the difference between nominal
bonds and inflation-linked bonds have also declined slightly
since the previous MPC meeting, with the five-year breakeven rate at 5.3%.
The global growth backdrop remains positive, with sustained
upswings evident in most regions. This is despite continued
uncertainty regarding economic policy reforms in the United
States (US). Nevertheless, growth rates and potential output
estimates are still generally lower than those in the pre-crisis
period. While there are lingering concerns about financial
Monetary Policy Review October 2017

stability risks from the shadow banking sector in China, the
recent strong performance of the economy has contributed
to the favourable environment for emerging markets.
Underlying global inflation trends remain benign, with
inflation below target in most of the advanced economies,
notwithstanding the positive growth prognosis and tightening
labour markets. An exception is the United Kingdom (UK)
where inflation has accelerated in the wake of the Brexitinduced depreciation of the pound sterling. The subdued
global inflation outlook is reinforced by generally slow wage
and productivity growth in developed economies.
Despite the absence of inflationary pressures, central banks
in a number of advanced economies have signalled their
intentions to move from highly accommodative monetary
policy stances. These countries include the US, the UK,
the euro area and Canada. This process is unlikely to be
smooth or perfectly synchronised and could generate bouts
of uncertainty. In the US, expectations of further near-term
rate increases by the US Federal Reserve (Fed) have been
scaled down following a succession of downside inflation
surprises. The gradual nature of the planned balance sheet
contraction by the Fed has also been well communicated
and appears to have been largely priced in by the markets.
While changing expectations regarding European Central
Bank and US monetary policy in particular have impacted
on a number of emerging market currencies and bond
yields, the reaction has been relatively muted, and a repeat
of the 2013 so-called taper tantrum episode is not expected.
Those economies that were most sensitive to that episode
have much improved macroeconomic balances, and
their currencies are less vulnerable to possible spillover
effects from gradual monetary tightening in the advanced
economies.
The rand has also been affected by these changing
expectations as well as by domestic political developments,
including concerns about a proposal to change the SARB’s
monetary policy mandate. While the rand has remained
more or less unchanged since the previous meeting of the
MPC, it has been relatively volatile, having fluctuated in a
range between R12.60 and R13.60 against the US dollar.
The rand’s relative resilience had been underpinned by the
generally positive sentiment towards emerging markets as
well as by sustained trade surpluses. The current account
deficit is still expected to widen over the forecast period,
but the degree of widening has been revised down. The
rand remains vulnerable to increased global risk aversion,
domestic political shocks, and to the possibility of further
ratings downgrades.
The domestic growth outlook remains a concern following
the surprise broad-based GDP growth contraction in the
first quarter of this year. With the exception of the primary
sector, all sectors recorded negative growth. While positive
growth is expected in the second quarter, the SARB’s
annual growth forecasts have been revised down further.
The forecast for 2017 has been adjusted down from 1.0% to
0.5%, and the forecast for 2018 is down from 1.5% to 1.2%.
Growth of 1.5% is expected in 2019, compared with 1.7%
previously.
As a result of these trends, the output gap has widened
somewhat despite a further downward revision to potential
output growth by 0.3 percentage points for each year, to
1.1% in 2017 and to 1.3% in 2019. The weak outlook is
consistent with the decline in the Rand Merchant Bank/
Bureau for Economic Research (RMB/BER) Business
Confidence Index to levels last seen during the recession
following the global financial crisis. The SARB’s composite
leading business cycle indicator has also moderated
somewhat since January.
Monthly data for both the mining and manufacturing sectors
in April and May suggest that, in the absence of a sharp
contraction in June, these sectors are likely to contribute
positively to growth in the second quarter, along with the
continued rebound in the agricultural sector. The recovery is
nevertheless expected to be modest, particularly in the light
of a sharp fall in the Absa Purchasing Managers’ Index in
June, which returned to below the neutral level of 50 index
points. The construction sector also remains under pressure
following the marked fall in building plans passed in the first
quarter of this year, with the negative trend continuing into
April.
The continued poor performance of gross fixed capital
formation contributes to the weak state of the economy.
Although private sector investment recorded positive growth
after five consecutive quarters of contraction, at a growth
rate of 1.2% it remains very subdued. Given the extremely
low level of business confidence, a near-term improvement
is unlikely. Policy uncertainty, a recent example being in the
mining sector, is likely to constrain investment.
As a consequence, employment growth has been minimal
and the prospects are unfavourable. Given the need for
fiscal consolidation, a continued decline in government’s
contribution to employment creation is expected. The
official unemployment rate increased to 27.7% in the first
quarter of this year.
Consumption expenditure by households contracted in
the first quarter of this year amid a further deterioration in
consumer confidence. Although the monthly retail sales
data suggest a more positive outcome for the second
quarter, this improvement is likely to be offset in part by a
decrease in new vehicle sales in the quarter. The outlook for
consumption expenditure is expected to remain weak amid
employment uncertainty and higher tax burdens.
These consumption trends are mirrored in the continued
moderation in credit extension to households. Growth in

Monetary Policy Review October 2017
mortgage advances and instalment sales credit finance
remained subdued, reflective of the difficult conditions in the
housing and vehicle markets. General loans to households
increased moderately in May, but off a low base. By contrast,
credit extension to the corporate sector remains relatively
buoyant, if on a downward trend.
Wage trends have been an important contributor to the
persistence of inflation at higher levels. There are, however,
indications of some moderation in average salaries and
related unit labour costs which are expected to remain
below the 6% level over the forecast period. The outcome
of a number of multi-year wage agreements that are due for
renewal in 2017 will be closely watched as they could pose
a risk to the inflation trajectory.
The persistent global oil supply glut, along with increased
shale gas production in the US, has undermined efforts
by the Organization of the Petroleum Exporting Countries
(OPEC) and other producers to support prices through
output restrictions. Since the beginning of June, Brent crude
oil prices have traded at levels below US$50 per barrel, and
the SARB’s oil price assumptions have been revised down
over the forecast period. These recent oil price trends,
along with the stronger exchange rate, contributed to a
69 cents per litre reduction in the petrol price in July.
Following a weakening of the rand and a partial recovery
in crude oil prices, a moderate petrol price increase is
expected in August.
The inflation outlook has improved significantly since the
previous meeting of the MPC and has been fairly broadbased. The lower core inflation outlook is indicative of
weaker underlying inflation pressures at a time when the
impact of exogenous shocks on headline inflation has been
dissipating. These shocks include drought-induced food
price inflation and, to a lesser extent, international oil price
increases earlier this year that have since been reversed.
A number of risks to the inflation outlook persist and the
MPC assesses the risks to the inflation outlook to be broadly
balanced. Although the rand has been relatively resilient, it
remains vulnerable to heightened political uncertainty, global
monetary policy developments and possible further credit
ratings downgrades. On the positive side, it is supported
by a sustained narrowing of the current account deficit and
positive investor sentiment towards emerging markets.
A further upside risk relates to the possible supply side
shock of a large electricity tariff increase from July next
year. Eskom has approached the National Energy Regulator
of South Africa (NERSA) for an increase of around 20%,
but the current forecast assumes an increase of 8%.
This assumption will be adjusted in line with any new
determinations made by NERSA.
The MPC also remains concerned that inflation expectations
remain sticky at the upper end of the target range. To the
extent that these expectations are formed adaptively, they
should adjust downwards if the lower inflation trajectory
is sustained. The MPC would prefer expectations to be
anchored closer to the midpoint of the target range.
The underlying demand in the economy is extremely weak
and the MPC is concerned about the deterioration in the
growth outlook over the forecast period. This decline is
broad-based. It is unclear where the drivers of accelerated
growth will come from in the absence of credible structural
policy initiatives that will reduce uncertainty and increase
business and consumer confidence. The MPC assesses
the risks to the revised growth forecast to be slightly on the
downside.
Given the improved inflation outlook and the deteriorated
growth outlook, the MPC has decided to reduce the
repurchase rate by 25 basis points with effect from
21 July 2017, to 6.75% per annum. Four members preferred
a reduction, while two members preferred an unchanged
stance.
As has been emphasised on numerous occasions, the
MPC does not view monetary policy as the solution to the
structural growth constraints in the economy, nor does
it believe that a reduction in interest rates will provide a
significant stimulus to growth in the current environment
of low confidence and political uncertainty. It will, however,
provide some relief at the margin.
In this highly uncertain environment, future policy decisions
will be dependent on data outcomes and our assessment
of the balance of risks. We remain vigilant and would not
hesitate to reverse this decision should the inflation outlook
and risks deteriorate.

Monetary Policy Review October 2017

Summary of assumptions: Monetary Policy Committee
meeting on 20 July 2017*
1. Foreign sector assumptions
Percentage changes (unless otherwise indicated)
Actual
Forecast

1. Real GDP growth in South Africa’s major trading-partner countries...


2. Domestic sector assumptions
Percentage changes (unless otherwise indicated)
Actual
Forecast


The figures in brackets represent the previous assumptions of the Monetary Policy Committee.
* For an explanation of foreign sector assumptions and domestic sector assumptions, see pages 51 and 52.

Monetary Policy Review October 2017
Forecast results (annual)
Percentage changes
Actual
Forecast


(-3.1)
(-4.1)
(-4.4)
The figures in brackets represent the previous forecasts of the Monetary Policy Committee.
Forecast results (quarterly)
Year-on-year percentage change
Actual
Forecast


The figures in brackets represent the previous forecasts of the Monetary Policy Committee.
Selected forecast results: Monetary Policy Committee meeting on 20 July 2017
Monetary Policy Review October 2017

Statement of the Monetary Policy Committee
21 September 2017
Issued by Lesetja Kganyago, Governor of the South African Reserve Bank,
at a meeting of the Monetary Policy Committee in Pretoria
The South African economy recorded positive growth
during the second quarter of 2017 following two consecutive
quarters of contraction. Growth prospects, however, remain
subdued as domestic fixed investment contracted further
amid low business confidence. The inflation forecast
has increased marginally since the previous meeting of
the Monetary Policy Committee (MPC), with increased
uncertainty regarding a number of the main drivers.
The global economy is on a recovery path. Inflation has
moderated in the emerging economies and remains benign
in most advanced economies. The statement released by
the Federal Open Market Committee (FOMC) yesterday
confirmed the gradual pace of reduction of its balance sheet
and normalisation of its policy rate. Along with continued
accommodative policies by the European Central Bank
(ECB), this is expected to contribute to the continuation
of favourable prospects for capital flows to emerging
economies.
The year-on-year inflation rate as measured by the consumer
price index (CPI) for all urban areas increased to 4.8% in
August, up from 4.6% previously, marginally below the
South African Reserve Bank’s (SARB) short-term forecast.
Food and non-alcoholic beverage inflation surprised on
the downside, moderating from 6.8% to 5.7%. Meat prices
continued to accelerate in August, having measured
15.0%, but the lower cereal prices contributed to the slowing
momentum. The SARB’s measure of core inflation, which
excludes food, fuel and electricity, measured 4.7% in July
and 4.6% in August, in line with the short-term forecast.
Year-on-year producer price inflation for final manufactured
goods declined from 4.0% in June to 3.6% in July. Food
products price inflation moderated further to 3.3% in July,
but the divergent trend of manufactured meat prices
continued with an increase of 17.8%. This trend was also
evident in agricultural prices, where the subcategory of ‘live
animals’ increased by 31.7%, while ‘products of crops and
horticulture’ declined by 26.9%.
The SARB’s forecast for headline CPI inflation is unchanged
at an annual average of 5.3% for 2017, and revised up by
0.1 percentage point to 5.0% and 5.3% for 2018 and 2019
respectively. A lower turning point of 4.6% is still expected
in the first quarter of 2018. The same pattern is observed
in the forecast for core inflation which is unchanged at
4.8% for 2017, but adjusted up to 4.9% and 5.0% for the
next two years. These forecasts do not incorporate the
most recent inflation outcome.
The main drivers of these changes are a lower repurchase
rate, a less appreciated exchange rate assumption, a slightly
narrower output gap and a marginal adjustment to the food
price forecast as meat prices continue to surprise on the
upside. Food price inflation is forecast to reach a low turning
point of 4.8% in the first quarter of 2018 and to average
7.3% in 2017, and 5.2% and 5.6% in 2018 and 2019
respectively. There may be some downside risk to this
forecast in light of the August food inflation outcomes.
The electricity tariff assumption remains unchanged at
8% from July next year, but there may be some upside risk
to this assumption, given Eskom’s recent application to the
National Energy Regulator of South Africa.
Inflation expectations as reflected in the survey conducted
by the Bureau for Economic Research at Stellenbosch
University in the third quarter of 2017 continue to be relatively
anchored at the upper end of the target range. Despite a
decline of 0.2 percentage points in the average expected
inflation for 2017 to 5.7%, expectations remain unchanged
at 5.8% and 5.9% for the next two years. Expectations of
analysts and business people moderated – although the
latter remains above the target range – while those of trade
unionists increased marginally. A welcome development is
that average five-year inflation expectations declined from
5.9% to 5.6%. This is the lowest level recorded since longterm expectations were first surveyed in 2011. Expectations
implicit in the difference between nominal bonds and
inflation-linked bonds are more or less unchanged since
the previous meeting, with the five-year break-even rate
at 5.2%.
Global conditions remain generally favourable despite some
geopolitical risks. The upswing appears to be synchronised
with increased world trade volumes. Growth in the Unites
States (US) is forecast to remain above potential in the short
to medium term, with the devastation caused by the recent
hurricanes expected to have only a limited and short-lived
impact on growth. The improved growth performance in the
euro area also appears to be sustained and region-wide,
while the Japanese economy has experienced moderate
growth in the past few quarters. By contrast, growth in the
United Kingdom has slowed following weak investment in
the face of the Brexit headwinds. The outlook for emerging
markets is also relatively positive amid generally improving
fundamentals.
Despite the improved growth outlook, global inflation
pressures remain benign, particularly in the advanced

Monetary Policy Review October 2017
economies. These trends are likely to contribute to the
persistence of accommodative monetary policy stances
in Japan and the euro area, where the recent appreciation
of the euro is likely to dampen inflation pressures further.
As expected, the US Federal Reserve (Fed) yesterday
announced a gradual reduction of its balance sheet. The
process had been communicated previously and was
largely priced in by the financial markets. The pace of policy
rate normalisation is also expected to remain measured as
inflation continues to surprise on the downside, despite
tightening labour market conditions. The stance of US fiscal
policy is a source of uncertainty. Although tax reductions
could lead to a faster pace of monetary tightening, the
prospect of significant tax reforms has receded over time.
The rand exchange rate has traded in a range of between
R13.54 and R12.74 since the previous meeting of the MPC,
driven in part by movements in the major currencies. Over
this period, the rand depreciated by 2.8% against the US
dollar, by 6.2% against the euro, and by 4.5% on a tradeweighted basis. The rand remains sensitive to political
developments, weak economic growth prospects and the
risk of further sovereign ratings downgrades. However, it
has been supported by persistent trade account surpluses
and associated narrowing of the current account deficit.
The rand has also been supported by the relatively
accommodative global monetary policy settings. These
have contributed to sustained demand for high-yielding
emerging market bonds. Net purchases by non-residents
of South African government bonds have amounted to
R63 billion in the year to date. The domestic yield curve
relative to other peer emerging market economies remains
attractive to non-residents despite a decline in the curve
across all maturities. However, longer-term bond yields and
the rand remain vulnerable to a large non-resident sell-off in
the event of further credit ratings downgrades, which would
result in South Africa falling out of the global bond indices.
The
domestic
economic
growth
outlook
remains
constrained despite the higher-than-expected growth
outcome of 2.5% in the second quarter of this year. This
broad-based improvement, while welcome, is not expected
to have a significant impact on the annual growth outcome.
The SARB’s forecast for growth in the gross domestic
product for 2017 has been revised up marginally from
0.5% to 0.6%, while the forecasts for 2018 and 2019 have
remained unchanged at 1.2% and 1.5% respectively. This
outlook is consistent with the SARB’s leading business cycle
indicator which has been weakening since the beginning of
the year, indicative of muted growth prospects. Business
confidence also remains at very low levels, despite the
slight improvement in the Rand Merchant Bank/Bureau
for Economic Research (RMB/BER) Business Confidence
Index during the third quarter.
All the major sectors, apart from construction, recorded
positive growth in the second quarter of 2017, with a
particularly strong performance in the agricultural sector.
The recovery in the manufacturing sector followed three
successive quarterly contractions, while the tertiary sector
reversed its one-quarter contraction. The limited monthly
data for the third quarter present a mixed picture at this stage.
Mining sector output contracted in July while manufacturing
recorded positive growth. However, the Absa Purchasing
Managers’ Index averaged 43.5 index points in the first two
months of the quarter, suggesting continued headwinds for
the sector.
The underlying weakness in the economy is evident in the
2.6% contraction in gross fixed capital formation during the
second quarter. Of particular concern is the 6.9% decline in
private sector fixed investment, reflecting the low levels of
business confidence. This subdued outlook is expected to
persist against a backdrop of continued political and policy
uncertainty.
These investment trends do not bode well for employment
creation in the economy. Total employment declined in
the second quarter of 2017 and the unemployment rate
remained unchanged at 27.7%. The public sector, previously
the main source of employment growth in the economy, is
likely to continue to shed jobs as fiscal constraints intensify.
Consumption expenditure by households rebounded
strongly in the second quarter following the sizeable
contraction in the previous quarter. Spending on all three
major goods components recovered, but expenditure
on services contracted. Despite the improved outcome,
the outlook for consumption expenditure growth remains
subdued, although positive, amid very low levels of
consumer confidence. Month-on-month retail trade sales
decreased in July, but motor vehicle sales remained relatively
strong in July and August. The SARB expects household
consumption growth to be in the region of 1% for this year.
The
underlying
drivers
of
household
consumption
expenditure remain unchanged. Lower inflation, lower
interest rates and higher real income growth are expected
to provide some support for consumption. Offsetting
effects include depressed consumer confidence, weak
employment growth, the absence of significant wealth
effects and the prospect of further tax increases in the wake
of fiscal revenue shortfalls.
In addition, growth in credit extension to the private
sector has declined steadily over the past few months,
as corporate demand for mortgage finance and general
loans in particular moderated. Growth in credit extension
to households remains weak and negative in real terms.
These trends are also reflected in continued household
deleveraging, with household debt to disposable income
Monetary Policy Review October 2017

declining further to 72.6% in the second quarter – its lowest
level since the beginning of 2006.
International oil prices have increased by about US$5 per
barrel since the previous meeting, with Brent crude oil
currently trading at around US$55 per barrel. Nevertheless,
the MPC does not expect a further sustained acceleration
in prices as the flexibility of US shale oil production is
expected to provide a ceiling to prices. The previous oil price
assumptions therefore remain unchanged. The domestic
price of 95 octane petrol has increased by a cumulative
86 cents per litre since August, mainly due to higher
international product prices. A further moderate increase is
expected in October.
The MPC expects inflation to remain within the target range
over the forecast period, closer to the midpoint than was the
case early in the year. Core inflation has remained relatively
stable, indicative of the absence of significant demand
pressures. However, a number of risks to the inflation
outlook have increased and the MPC assesses the risks to
the inflation outlook to be somewhat on the upside.
The rand remains a key upside risk to the inflation outlook.
Furthermore, some of the event risks, particularly those of a
political nature, are now more imminent but with no greater
degree of clarity regarding the outcome. The prospect of
a further ratings downgrade persists, particularly given the
increased fiscal challenges and political uncertainty. The
narrower current account deficit and the global environment
remain supportive of the rand. However, should inflation
and/or growth surprise on the upside in Europe and in the
US in particular, we could see a faster pace of monetary
tightening, which could impact on capital flows and the rand
exchange rate. At this stage, markets appear to be pricing
a high probability of an increase in the Federal funds rate in
December, and three further increases next year.
A further upside risk relates to the possibility of a large
electricity tariff increase than is currently assumed in our
forecast from July next year. A tariff increase of 20% could
raise the headline inflation forecast by between 0.2 and
0.3 percentage points, and the MPC will continue to assess
the possible second round effects of these increases.
The MPC remains concerned that inflation expectations of
business people and trade unions remains above or close
to 6% for the next two years, even though our own forecast
and those of most analysts expect inflation to be much
closer to 5%. Lower inflation expectations among key price
setters are an important element in reducing inflation in the
future, thus enabling lower nominal interest rates.
Until August, food price inflation had been moderating at
a slower pace than expected, mainly due to the continued
acceleration in meat prices. However, the August year-
on-year outcome surprised significantly on the downside.
Should this lower trajectory continue there could be
a downside risk to the food price forecast and to the overall
inflation outlook, particularly in the short term.
Although household consumption expenditure rebounded
strongly in the second quarter, the MPC does not view
this as indicative of the longer-term trend of expenditure,
which is expected to remain constrained. The secondquarter growth outcome, while positive, does not change
our growth forecast significantly, and the outlook remains
weak. The MPC assesses the risks to the revised growth
forecast to be slightly on the downside.
In light of these developments and the deteriorating
assessment of the balance of the risks, the MPC has
decided to keep the repurchase rate unchanged at
6.75% per annum. Three members preferred an unchanged
stance and three members preferred a 25 basis point
reduction. Ultimately, the Committee decided to keep the
rate unchanged.
Given the heightened uncertainties in the economy, the
MPC felt it would be appropriate to maintain the current
monetary policy stance at this stage, and reassess the data
and the balance of risks at the next meeting.

Monetary Policy Review October 2017
Summary of assumptions: Monetary Policy Committee
meeting on 21 September 2017*
1. Foreign sector assumptions
Percentage changes (unless otherwise indicated)
Actual
Forecast

1. Real GDP growth in South Africa’s major trading-partner countries...


2. Domestic sector assumptions
Percentage changes (unless otherwise indicated)
Actual
Forecast


The figures in brackets represent the previous assumptions of the Monetary Policy Committee.
* For an explanation of foreign sector assumptions and domestic sector assumptions, see pages 51 and 52.
Monetary Policy Review October 2017

Forecast results (annual)
Per cent
Actual
Forecast


(-2.7)
The figures in brackets represent the previous forecasts of the Monetary Policy Committee.
Forecast results (quarterly)
Year-on-year percentage change
Actual
Forecast


The figures in brackets represent the previous forecasts of the Monetary Policy Committee.
Selected forecast results: Monetary Policy Committee meeting on 21 September 2017

Monetary Policy Review October 2017
Foreign sector assumptions
1. Trading-partner gross domestic product (GDP) growth
is determined broadly via the International Monetary
Fund’s (IMF) Global Projection Model (GPM), which is
then adjusted to aggregate the GDP growth rates of
South Africa’s major trading partners on a trade-weighted
basis. Individual projections are done for the four largest
trading partners (euro area, China, the United States
(US) and Japan), while the remaining trading partners
are grouped into three regions: emerging Asia (excluding
China), Latin America and the Rest of Countries bloc.
The assumption takes account of country-specific
‘consensus’ forecasts as well as IMF regional growth
prospects.
2. The commodity price index is a weighted aggregate
price index of the major South African export commodities based on 2010 prices. The composite index
represents the total of the individual commodity prices
multiplied by their smoothed export weights. Commodity
price prospects generally remain commensurate with
global liquidity as well as commodity demand/supply
pressures as reflected by the pace of growth in the
trading-partner countries.
3. The Brent crude oil price is expressed in US dollars
per barrel. The assumption incorporates the analysis
of factors of supply, demand (using global growth
expectations) and inventories of oil (of all grades) as
well as the expectations of the US Energy Information
Administration (EIA), the Organization of the Petroleum
Exporting Countries (OPEC) and Reuters.
4. World food prices are the composite food price index
of the United Nations Food and Agriculture Organization
(FAO) in US dollars. The index is weighted using average
export shares and represents the monthly change in the
international prices of a basket of five food commodity
price indices (cereals, vegetable oil, dairy, meat and
sugar). World food price prospects incorporate selected
global institution forecasts for food prices as well as
imbalances from the anticipated trend in international
food supplies relative to expected food demand
pressures.
5. International wholesale prices refers to a weighted
aggregate of the producer price indices of South
Africa’s major trading partners, as per the South African
Reserve Bank’s (SARB) official real effective exchange
rate calculation. Although individual country consumer
price index (CPI) inflation forecasts provide a good
indication for international wholesale price pressures,
the key drivers for the assumed trend in global wholesale
inflation are oil and food prices as well as expected
demand pressures emanating from the trends in the
output gaps of the major trading-partner countries.
Other institutional forecasts for international wholesale
prices are also considered.
6. The real effective exchange rate is the nominal effective
exchange rate of the rand deflated by the producer price
differential between South Africa and an aggregate of
its trading-partner counties (as reflected in the Quarterly
Bulletin published by the SARB). Although the nominal
rate is a weighted average of South Africa’s 20 largest
trading partners, particular focus is placed on the rand
outlook against the US dollar, euro, Chinese yuan, British
pound and the Japanese yen. The assumed trend in the
real effective exchange rate remains constant from the
latest available quarterly average over the projection
period. However, due to the time delay in the calculation
of the real effective exchange rate, the most recent trend
in the nominal effective exchange rate is adjusted with
the assumed trend for the domestic and foreign price
differential for the current quarter. This may result in a
technical annual adjustment over the current and next
forecast year that differs from zero.
Monetary Policy Review October 2017

Domestic sector assumptions
1. Government consumption expenditure (real) is broadly
based on the most recent National Treasury budget
projections. However, since these projections take place
twice a year, the most recent actual data points also play
a significant role in the assumptions process.
2. Administered prices represent the total of regulated
and non-regulated administered prices as reflected by
Statistics South Africa (Stats SA). Their weight in the
CPI basket is 16.17% and the assumed trend over the
forecast period is largely determined by the expected
pace of growth in petrol prices, electricity tariffs, school
fees, and water and other municipal assessment rates.

The petrol price is an administered price and comprises
4.58% of the CPI basket. The basic fuel price (which
currently accounts for roughly half of the petrol price),
is determined by the exchange rate and the price of
petrol quoted in US dollars at refined petroleum centres
in the Mediterranean, the Arab Gulf and Singapore.
The remainder of the petrol price is made up of
wholesale and retail margins as well as the fuel levy and
contributions to the Road Accident Fund (RAF). Since
most taxes and retail margins are changed once a year,
the assumed trajectory of the petrol price largely reflects
the anticipated trend in oil prices and the exchange rate.

The electricity price is an administered price measured
at the municipal level with a weight of 3.75% in the
headline CPI basket. Electricity price adjustments
generally take place in July and August of each year,
and the assumed pace of increase over the forecast
period reflects the multi-year price determination
(MYPD) agreement between Eskom and the National
Energy Regulator of South Africa (NERSA), with a slight
adjustment for measurement at municipal level.
3. The pace of potential growth is derived from the
SARB’s semi-structural potential output model. The
measurement accounts for the impact of the financial
cycle on real economic activity and introduces economic
structure via the relationship between potential output
and capacity utilisation in the manufacturing sector
(South African Reserve Bank Working Paper Series
No. WP/14/08).
4. The repurchase rate (repo rate) is the official monetary
policy instrument and represents the interest rate at
which banks borrow money from the SARB. Although
the rate is held constant over the forecast period, this
assumption is relaxed in alternative scenarios where, for
instance, the policy rate responds to deviations of output
from its potential and the gap between future inflation
and the inflation target, that is, via a stylised ‘Taylor rule’;
one that is based on market expectations of the future
path of the policy rate, and other paths as requested.

Monetary Policy Review October 2017
Glossary
Advanced economies: Advanced economies are countries
with high levels of gross domestic product per capita. These
countries are sometimes described as industrialised. With
further growth, however, they have tended to diversify, with
particular emphasis on services sectors.
Balance of payments: This is a record of transactions
between the home country and the rest of the world over a
specific period of time. It includes the current and financial
accounts. See also ‘current account’ below.
Budget deficit: A budget deficit indicates the extent to which
government expenditure exceeds government revenue (a
budget surplus occurs when revenue exceeds expenditure).
Business and consumer confidence: These are economic
indicators that measure the state of optimism about the
economy and its prospects among business managers and
consumers.
Commodity prices: Commodities can refer to energy,
agriculture, metals and minerals. Major South Africanproduced commodities include platinum and gold.
Consumer price index (CPI): The CPI provides an indication
of aggregate price changes in the domestic economy. The
index is calculated using a number of categories forming
a representative set of goods and services bought by
consumers.
Core inflation: Core generally refers to underlying inflation,
excluding volatile elements (e.g. food and energy prices).
The SARB’s forecasts and discussions refer to headline CPI
excluding food, non-alcoholic beverages, fuel and electricity
prices.
Crude oil price: This is the US dollar price per barrel of
unrefined oil (Brent crude refers to unrefined North Sea oil).
Current account: The current account of the balance of
payments consists of net exports (exports less imports)
in the trade account, as well as the services, income and
current transfer account.
Emerging markets: Emerging markets are countries with
low to middle income per capita. They are advancing rapidly
and are integrating with global (product and capital) markets.
Exchange rate depreciation (appreciation): Exchange rate
depreciation (appreciation) refers to a decrease (increase) in
the value of a currency relative to another currency.
Exchange rate pass-through: This is the effect of exchange
rate changes on domestic inflation (i.e. the percentage
change in domestic CPI due to a change in the exchange
rate). Changes in the exchange rate affect import prices,
which in turn affect domestic consumer prices and inflation.
Flexible inflation targeting: This refers to inflation-targeting
regimes that consider changes in inflation and other variables
affecting the real economy in the short term. Under strict
inflation targeting only inflation matters, but flexible inflationtargeting takes into account other variables, such as output.
Forecast horizon: This is the future period over which the
SARB generates its forecasts, typically between two and
three years.
Gross domestic product (GDP): GDP is the total market
value of all goods and services produced in a country. It
includes total consumption expenditure, capital formation,
government consumption expenditure and the value of
exports less the value of imports.
Gross fixed capital formation (investment): The value of
acquisitions of capital goods (e.g. machinery, equipment
and buildings) by firms, adjusted for disposals, constitutes
gross fixed capital formation.
Headline consumer price index (CPI): Headline CPI refers
to CPI for all urban areas that is released monthly by
Statistics South Africa. Headline CPI is a measure of price
levels in all urban areas. The 12-month percentage change
in headline CPI is referred to as ‘headline CPI inflation’ and
reflects changes in the cost of living. This is the official
inflation measure for South Africa.
Household consumption: This is the amount of money
spent by households on consumer goods and services.
Inflation (growth) outlook: This outlook refers to the evolution
of future inflation (growth) over the forecast horizon.
Inflation targeting: This is a monetary policy framework
used by central banks to steer actual inflation towards an
inflation target level or range.
Median: This is a statistical term used to describe the
observed number that separates ordered observations in half.
Monetary policy normalisation: This refers to the unwinding
of unusually accommodative monetary policies. It could
also mean adjusting the economy’s policy rate towards its
real neutral policy rate.
Nominal effective exchange rate (NEER): A NEER is an
index that expresses the value of a country’s currency
relative to a basket of other (trading partner) currencies. An
increase (decrease) in the effective exchange rate indicates
a strengthening (weakening) of the domestic currency with
respect to the selected basket of currencies. The weighted
average exchange rate of the rand is calculated against
20 currencies. The weights of the five major currencies
are as follows: euro (29.26%), Chinese yuan (20.54%),
US dollar (13.72%), Japanese yen (6.03%) and the British
pound (5.82%). Index: 2010 = 100. See ‘Real effective
exchange rate’.
Monetary Policy Review October 2017

Output gap/potential growth: Potential growth is the
rate of GDP growth that could theoretically be achieved
if all productive assets in the economy were employed
in a stable inflation environment. The output gap is the
difference between actual growth and potential growth,
which accumulates over time. If this is negative, then the
economy is viewed to be underperforming and demand
pressures on inflation are low. If the output gap is positive,
the economy is viewed to be overheating and demand
pressures are inflationary.
Producer price index (PPI): This index measures changes
in the prices of goods at the factory gate. Stats SA currently
produces five different indices that measure price changes
at different stages of production. Headline PPI is the index
for final manufactured goods. PPI measures indicate
potential pressure on consumer prices.
Productivity: Productivity indicates the amount of goods
and services produced in relation to the resources utilised
in the form of labour and capital.
Purchasing power parity (PPP): PPP is based on the law
of one price, assuming that in the long run, exchange rates
will adjust so that purchasing power across countries is
approximately the same. It is often used to make crosscountry comparisons without the distortionary impact of
volatile spot exchange rates.
Real effective exchange rate (REER): The REER is the
NEER adjusted for inflation differentials between South
Africa and its main trading partners. See ‘Nominal effective
exchange rate’.
Repurchase (repo) rate: This is the policy rate that is set
by the Monetary Policy Committee (MPC). It is the rate that
commercial banks pay to borrow money from the SARB.
Real repo rate: This is the nominal repo rate, as set by the
MPC, adjusted for expected inflation.
Taper tantrum: The term ‘taper tantrum’ is widely used
to describe the strong reaction of global financial markets
to comments by the US Federal Reserve (Fed) chairman
in May 2013 that the Fed would likely start to reduce (or
‘taper’) the pace of its asset purchases later that year.
Terms of trade: This refers to the ratio of export prices to
import prices.
Unit labour costs: A unit labour cost is the labour cost to
produce one ‘unit’ of output. This is calculated as the total
wages and salaries in the non-agricultural sector divided by
the real value added at basic prices in the non-agricultural
sector of the economy.

Monetary Policy Review October 2017
Abbreviations
BER

Bureau for Economic Research
BIS

Bank for International Settlements
CPI

consumer price index
ECB

European Central Bank
Fed

United States Federal Reserve
FNB

First National Bank
FOMC

Federal Open Market Committee
FRA

forward rate agreement
G3

Group of Three
GDP

gross domestic product
GFCG

gross fixed capital formation
IMF

International Monetary Fund
MPC

Monetary Policy Committee
MPR

Monetary Policy Review
MTBPS

Medium Term Budget Policy Statement
NAB

non-alcoholic beverage
NERSA

National Energy Regulator of South Africa
NIDS

National Income Dynamics Study
NRIR

neutral real interest rate
OPEC

Organization of the Petroleum
Exporting Countries
PCE

personal consumption expenditure
PPP

purchasing power parity
QPM

Quarterly Projection Model
repo (rate)
repurchase (rate)
RMB

Rand Merchant Bank
RMSE

root mean square error
S&P

Standard & Poor’s
SACCI

South African Chamber of Commerce
and Industry
SALDRU

South African Labour and
Development Research Unit
SARB

South African Reserve Bank
SOE

state-owned enterprise
Stats SA
Statistics South Africa
UK

United Kingdom
ULC

unit labour cost
US

United States
VAT

value-added tax
VIX

Chicago Board Options
Exchange Volatility Index
ZAR

South African rand