South African Reserve Bank

EMBARGO DELIVERY
24 November 2016

STATEMENT OF THE MONETARY POLICY COMMITTEE

Issued by Lesetja Kganyago, Governor of the South African Reserve Bank

Since the previous meeting of the Monetary Policy Committee, the global economic
and political landscape has changed significantly following the US presidential
election. The high degree of uncertainty surrounding the economic policies of the
new administration is expected to persist for some time, creating a more challenging
and volatile environment for emerging markets in particular. Higher US long bond
yields, along with expectations of a tighter stance of monetary policy by the US Fed
than previously expected, have contributed to the reversal of the recent positive
sentiment towards emerging markets. The prospect of rising protectionism and its
implications for world trade are also a concern.
These developments have also affected capital flows to South Africa, with
implications for the rand and bond yields. Domestic growth and inflation dynamics
have remained more or less in line with expectations, but risks to the inflation outlook
have increased moderately.

The year-on-year inflation rate as measured by the consumer price index (CPI) for all
urban areas measured 6,1 per cent and 6,4 per cent in September and October
respectively, compared with 5,9 per cent in August. The October outcome was
marginally above the Bank’s forecast. Food price inflation accelerated further to a
recent high of 12,0 per cent, with the category of food and non-alcoholic beverages
contributing 1,8 percentage points to the overall inflation outcome. Goods price
inflation measured 7,1 per cent in October, up from 6,6 per cent in September, with
non-durable goods inflation increasing to 7,6 per cent. Services price inflation
increased from 5,6 per cent to 5,8 per cent. The Bank’s measure of core inflation,
which excludes food, fuel and electricity measured 5,7 per cent, up from 5,6 per
cent.
Producer price inflation for final manufactured goods measured 6,6 per cent in
September and October, down from 7,2 per cent in August. The main contributor to
the October outcome was the category of food products, beverages and tobacco
products which contributed 4,0 percentage points, and reflects the continued impact
of the drought on food prices.
The latest inflation forecast of the Bank is broadly unchanged over the forecast
period, despite a moderate upward adjustment to the food price forecast in the later
quarters. The annual averages are unchanged at 6,4 per cent for 2016, and 5,8 per
cent and 5,5 per cent in the coming two years. Inflation is expected to peak at 6,6
per cent in the fourth quarter of this year, marginally lower than in the previous
forecast, with a sustained return to within the target range still expected to occur

during the second quarter of 2017. The higher food price assumption is offset by a
slightly more appreciated exchange rate assumption.
Core inflation is expected to average 0,1 percentage point less in each year of the
forecast period, compared with the previous forecast, at 5,6 per cent this year, and
5,5 per cent and 5,2 per cent in 2017 and 2018. Core inflation is expected to remain
within the target range over the forecast period, with a peak of 5,8 per cent in the
final quarter of this year.
The annual inflation expectations of economic analysts, as reflected in the Reuters
Econometer survey conducted in November, are broadly unchanged since
September, and are similar to those of the Bank. The median forecast for the current
and next two years are 6,3 per cent, 5,8 per cent and 5,6 per cent. Bond market
expectations implicit in the breakeven inflation rates, i.e. the yield differential
between conventional government bonds and inflation-linked bonds, increased in the
wake of the recent depreciation of the rand. They remain above the upper end of the
inflation target range.
The global outlook has become increasingly uncertain during the year following the
UK decision to leave the European Union, and the outcome of the US presidential
election. While the new policy direction in the US is still unclear, the markets have
interpreted the outcome as being positive for US growth in the short run, with
commitments to tax cuts and higher fiscal spending on infrastructure. These policies
are expected to result in higher growth and inflation, particularly against the
backdrop of an increasingly tight labour market. Nevertheless, the timing and extent
of the expenditure boost is highly uncertain at this stage.

While an increase in infrastructure expenditure could be positive for commodity
prices, other aspects of the possible new policy direction are likely to have an
adverse effect on emerging markets. These include a possible more aggressive
tightening of US monetary policy in response to higher inflation and growth, which
could also reduce the multiplier effect of the fiscal expansion. Together with the
recent sharp increase in US long bond yields, the possibility of such actions has led
to a reversal of capital flows to emerging markets, reminiscent of the market reaction
to the so-called US taper tantrum in 2013. The impact on emerging market
currencies and bond markets, including in South Africa, are already evident. Given
the high degree of uncertainty, the financial markets may have over-reacted.
A further concern for emerging markets is the potential change of trade policies that
may impact on existing trade treaties, as well as unilateral increases in tariff
protection in the US. The outlook for emerging markets has therefore become more
uncertain. The lingering concerns about the sustainability of the recovery in the
Chinese economy have been revived by the possibility of tariff increases on Chinese
exports. Countries with strong direct trade links with the US, in particular Mexico, are
most vulnerable to increased trade barriers. A more protectionist US stance could
reinforce the already slow growth of global trade.
The short-term fallout of Brexit on the UK economy has been limited to date, due in
part to the accommodative monetary policy response. The longer-term impact
remains unclear as the terms of withdrawal are still to be negotiated, and there are
concerns that a delay in clarity could undermine investment. The Eurozone is
expected to continue with its slow but steady recovery, and the Japanese economy
continues to battle with deflation.

Global inflation remains generally benign and since the previous meeting of the MPC
a number of countries have loosened monetary policy. Expansionary policies are
expected to persist in the Eurozone, Japan and the UK, despite emerging inflation
pressures in the latter. By contrast, a persistence of significant outflows from
emerging markets in response to the possibility of a tighter US monetary policy
stance could pose challenges for monetary policies in a number of these economies.
These new global developments have impacted on the domestic bond and foreign
exchange markets. The rand appreciated steadily from the middle of October in
response to some positive domestic developments, as well as inflows from a large
M&A transaction. The currency was trading at around R13,20 against the US dollar
just before the elections. It then reached its weakest point of R14,60 against the US
dollar in the wake of the surprise outcome, before recovering somewhat. Domestic
long bond yields (R186) initially spiked by about 60 basis points, but the increase
has since moderated to about 25 basis points. Since the previous meeting of the
MPC, the rand has depreciated by about 5,7 per cent against the US dollar, and by
about 1,1 per cent on a trade-weighted basis.
The rand is expected to remain sensitive to changes in the stance of US monetary
policy. A US rate increase is generally expected in December and probably largely
priced in, but of greater significance for the rand will be the signals from the FOMC
regarding the trajectory of future increases. The rand will also remain sensitive to the
sovereign ratings announcements due later this month and early in December.
On the positive side, the rand has been given support by the generally improved
trade account in recent months. However, the deficit on the current account of the
balance of payments is expected to have widened in the third quarter of this year.

The financing of the deficit may become more challenging should the recent
significant non-resident sales of bonds and equities persist. During October and
month-to-date, non-residents have been net sellers of domestic bonds and equities
to the value of R42,7 bn and R19,7 bn respectively.
The domestic economic growth outlook remains subdued, although the low point of
the cycle appears to be behind us. The Bank’s forecast remains unchanged at 0,4
per cent for 2016, and 1,2 per cent and 1,6 per cent for the next two years. While the
estimate for potential GDP growth was revised down marginally to 1,3 per cent, and
rising to 1,5 per cent by 2018, the output gap is expected to remain negative over the
forecast period. The Bank’s composite leading business cycle indicator improved in
August and September, continuing a recent generally positive but gradual upward
trend.
Available monthly data suggest that growth in the third quarter is likely to be positive
but well below the rate recorded in the second quarter. The mining sector contributed
positively to GDP growth in the quarter. The physical volume of manufacturing output
declined, despite a positive month-to-month outcome in September. The Barclays
Purchasing Managers’ Index (PMI), which declined further in October, has remained
below the neutral 50 index point level for three consecutive months. The weak trends
in manufacturing are consistent with the continued low levels of business confidence,
despite a moderate improvement in the third quarter. More positively, the services
sector is expected to sustain its positive growth rate, with the tourism sector being
particularly buoyant.

Consumption expenditure by households remains subdued, with declining retail
trade sales, and static wholesale trade sales in the third quarter of this year.
Although new motor vehicle sales increased sharply on a month-to-month basis in
October, a sizeable proportion of this is attributed to car rental companies, and
challenging conditions in the new vehicle sector persist.
Consumers continue to face a number of constraints. Employment growth is
particularly weak; household debt levels, while moderating, are still elevated; and
wealth effects are muted amid stagnant equity and residential property markets.
Furthermore, growth in credit extension to households remains subdued.
Slow growth in household disposable incomes is also reflected in a gradual decline
in wage growth, with growth in nominal remuneration per worker declining to 5,8 per
cent in the second quarter. When an adjustment is made for the increase in labour
productivity, growth over four quarters in nominal unit labour costs measured 5,1 per
cent in the second quarter. The Andrew Levy Employment Publications Survey
reports an average wage settlement rate in collective bargaining agreements of 7,5
per cent in the first three quarters of the year, and 7,1 per cent in the third quarter.
This may be indicative of wage settlements becoming more sensitive to the
persistently high unemployment rates.
According to the Medium Term Budget Policy Statement (MTBPS) released in
October, fiscal consolidation is set to continue at a measured pace. A moderate
degree of slippage is expected in the near term, as tax receipts are negatively
affected by the economic slowdown. In order to prevent an excessive widening of the
fiscal deficit, the MTBPS proposes a reduction in the expenditure ceiling and tax
increases to be announced in February. A revised deficit of 3,4 per cent of GDP is

expected in the current fiscal year, and steadily narrowing to 2,5 per cent of GDP in
the 2019/20 fiscal year.
Food price inflation remains a significant driver of inflation, and is sensitive to the
continuing drought. While food price inflation is still expected to moderate from early
2017, the pace of decline is expected to be slower than previously forecast. This has
led to an upward revision to the food price assumption in the forecast during the
outer quarters in particular. The change is mainly due to the delayed impact of meat
prices which are now expected to peak only in early 2018, as farmers rebuild their
herds during 2017.
Brent crude oil prices reached a year high of US$52 per barrel in early October
following the OPEC agreement to curtail production. Since then, prices have
declined following doubts about the prospects for an agreement on the distribution of
production cuts across the cartel. Some price volatility is expected in the short run
as negotiations on production cuts continue. The Bank’s forecast maintains the
assumption of a moderate upward trajectory of international oil prices over the
forecast period. The domestic price of 93 octane petrol increased by a cumulative 88
cents per litre in October and November, with almost all of the increase due to higher
international product prices. The current over-recovery indicates that should current
trends persist, about half of that increase could be reversed in December.

The MPC is of the view that a high degree of uncertainty surrounds the nature and
timing of possible policy changes emanating from significant developments in the
global economic environment. This elevated uncertainty creates a more challenging
environment especially for emerging markets as evidenced in the recent changed
pattern of capital flows. Financial markets are thus likely to remain volatile for some
time.
Since the previous meeting of the MPC the inflation forecast has remained largely
unchanged. Whereas the risks to the inflation forecast were previously assessed to
be more or less balanced, the Committee now assesses the risks to be moderately
to the upside. This is mainly due to the possible impact of adverse global
developments on the exchange rate. The risk of domestically generated shocks to
the exchange rate also remain. Nevertheless, despite its high degree of volatility, the
rand has displayed relative resilience in the face of numerous shocks over the past
year.
The domestic growth outlook is unchanged and remains constrained against the
backdrop of weak business and consumer confidence. The risks to the growth
forecast are assessed to be broadly balanced. Domestic demand pressures remain
weak, and consumers are expected to remain under pressure for some time.
The MPC has accordingly decided to keep the repurchase rate unchanged at 7,0 per
cent per annum. The decision was unanimous.
The MPC remains concerned that the inflation trajectory is uncomfortably close to
the upper end of the target range. Furthermore, the uncertain environment and
moderately higher risks to the inflation outlook require continued vigilance. While the

Committee retains the view that we may be close to the end of the hiking cycle, there
may be a reassessment of this position should the upside risks transpire.

Lesetja Kganyago
GOVERNOR

Contact person:
Nosipho Theyise
+27 12 313 3465