Monetary Policy
Review


May 2010
Monetary Policy
Review
May 2010
South African Reserve Bank
Monetary Policy Review May 2010
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ISSN: 1609-3194
Produced by the Publishing Section
South African Reserve Bank
Monetary Policy Review May 2010
Contents
Monetary Policy Review


Statements issued by Ms G Marcus, 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


Boxes


Exchange rate pass-through in South Africa: Panel evidence from individual goods

Figures


Real renumeration per worker, labour productivity and unit labour cost in the formal


South African Reserve Bank
Monetary Policy Review May 2010


Tables


Real value of building plans passed and buildings completed in larger municipalities...


South African Reserve Bank

Monetary Policy Review May 2010
Monetary Policy Review
Introduction
The global economic recovery has progressed more rapidly than expected in the period
since the previous Monetary Policy Review was published in November 2009. However,
activity is recovering at varying speeds in different regions, and significant risks and
uncertainties continue to threaten global financial markets. Concerns regarding the
solvency of a number of countries in the euro area have threatened to transform the initial
banking crisis into a sovereign debt crisis, which could have systemic implications for the
global economy. The domestic economy, after contracting for three successive quarters,
recorded consecutive quarters of positive growth in the second half of 2009, and is
expected to sustain this stronger performance in 2010 and 2011.
Inflation has continued to trend downwards in recent months. Headline inflation has
moved to within the inflation target range of 3 to 6 per cent for the first time since April
2007 when a year-on-year increase of 5,9 per cent was recorded in October 2009.
After again breaching the upper limit of the inflation target range for technical reasons in
December 2009 and January 2010, inflation has moved back to within the target range
on a sustainable basis since February 2010.
In this Monetary Policy Review the latest developments in inflation and the factors that
impact on inflation are analysed. Recent monetary policy developments are reviewed,
and the outlook for inflation and the inflation forecast are presented. In addition, two
topical issues are addressed in boxes. The first box reproduces the clarification of the
mandate of the South African Reserve Bank (the Bank) issued by the Minister of
Finance, Mr P J Gordhan, in February 2010. The second box reports on research
undertaken on exchange rate pass-through at the disaggregated level in South Africa
using two distinct panels of data.
Recent developments in inflation
This section analyses recent trends in the main inflation indices and reviews
developments in the core determinants of inflation in the South African economy.
The evolution of indicators of inflation
Figure 1 shows that the year-on-year percentage change in the headline consumer price
index for all urban areas (CPI), the measure of inflation targeted by the Bank, has
continued to trend downwards in the period since the previous Monetary Policy Review
was published in November 2009. CPI inflation moved to within the inflation target range
of 3 to 6 per cent for the first time since April 2007 when a rate of 5,9 per cent was
recorded in October 2009. After breaching the upper limit of the inflation target range for
technical reasons in December 2009 and January 2010, inflation has moved back to
within the range since February 2010. The CPI inflation rate was 6,3 per cent in
December 2009 and 6,2 per cent in January 2010, followed by 5,7 per cent in February
and 5,1 per cent in March.
The main contributors to CPI inflation in the period since September 2009 have been the
housing and utilities, and miscellaneous goods and services categories (Table 1).
Housing and utilities contributed between 1,6 and 1,7 percentage points over the
period, reflecting mainly electricity and other fuel price changes. The contribution of
miscellaneous goods and services declined from 1,6 percentage points in September
2009 to 1,2 percentage points in March 2010. However, the main reason for the decline

in the overall CPI inflation rate was the contribution of the food and non-alcoholic
beverages category, which decreased from 0,9 percentage points in September 2009,
when CPI inflation was 6,1 per cent, to 0,2 percentage points in March 2010 when CPI
inflation was 5,1 per cent. Upward pressure emerged from the contribution of the
transport category, which increased from -0,3 percentage points in October 2009 to
0,7 percentage points in March 2010. This increase was largely due to higher petrol
prices. On a year-on-year basis, petrol prices increased by 22,1 per cent in February and
by 14,9 per cent in March.
Table 1
Contributions to CPI inflation
Percentage change over 12 months* and percentage points

Sep
Oct
Nov
Dec
Jan
Feb
Mar

Of which:

Miscellaneous goods and services ....

NAB: Non-alcoholic beverage
Source: Statistics South Africa
The continued decline in food inflation is evident from Figure 2, which shows that the
year-on-year inflation rate for all food items decreased from 4,9 per cent in September
2009 to 0,5 per cent in March 2010. Bread and cereals and meat products have
contributed negatively to food inflation in 2010, partly as a result of a decline in the price
of maize, which is an input into their production.
Monetary Policy Review May 2010
South African Reserve Bank
Percentage change over 12 months

Figure 1
Consumer price inflation: Targeted inflation*
* CPIX for metropolitan and other urban areas until the end of 2008; CPI for all urban
areas thereafter
Source: Statistics South Africa

Maize prices have fallen sharply in recent months, mainly driven by consecutive bumper
harvests, lower international prices, an appreciation of the exchange rate of the rand,
expectations that maize deliveries are likely to be close to forecast levels and good weather
across South Africa’s maize growing regions. The current maize harvest is projected to
approach the record set in the 1981/82 season, when 14,4 million ton were harvested. The
spot price of yellow maize declined from R1 549 per ton in mid-December 2009 to around
R1 200 per ton in May 2010 (Figure 3). Futures prices suggest that yellow maize prices will
rise slightly to around R1 277 per ton at the end of 2010.
Table 2 considers developments in a number of measures of core inflation, calculated by
excluding food, petrol and electricity prices from headline inflation. If petrol prices alone
South African Reserve Bank

Monetary Policy Review May 2010
Percentage change over 12 months

Figure 2
Targeted inflation* and food inflation
All food items
Meat
Vegetables
Bread and cereals
Milk, cheese and eggs
Targeted inflation measure
-10

* CPIX for metropolitan and other urban areas until the end of 2008, CPI for all urban
areas thereafter
Source: Statistics South Africa
Figure 3
Yellow maize prices

Rand per ton

Yellow maize spot price

Yellow maize futures prices (11 May 2010)
Sources: Grain South Africa and SAFEX


were excluded, inflation for the remaining items in the CPI was higher than headline
inflation until November 2009 and lower thereafter, reflecting the upward pressure that
has been exerted on inflation by petrol prices since December. The CPI excluding petrol
prices recorded a year-on-year inflation rate of 4,8 per cent in March 2010, compared to
the headline CPI inflation rate of 5,1 per cent. Food prices have continued to put
downward pressure on CPI inflation in the period since September 2009, resulting in the
inflation rate for the CPI excluding food and non-alcoholic beverage prices being
consistently higher than the headline CPI rate. If both petrol prices and food and nonalcoholic beverage prices were excluded, inflation for the remaining items in the CPI was
higher than headline inflation in all the months except January 2010, where the two rates
were equal. Finally, if petrol, food and non-alcoholic beverage and energy prices were
excluded, Table 2 reports that the resulting inflation rate was lower throughout the period
under review than the rate for CPI excluding petrol and food and non-alcoholic beverage
prices, reflecting the upward pressure placed on inflation by energy prices.
Table 2
The effect of food, petrol and electricity prices on headline inflation
Percentage change over 12 months

Sep
Oct
Nov
Dec
Jan
Feb
Mar

CPI excluding food and NAB* prices...

CPI excluding food, NAB and

CPI excluding food, NAB, petrol and

NAB: Non-alcoholic beverage
Source: Statistics South Africa
The inflation rates for goods and services prices in the CPI are reported in Table 3.
Goods price inflation remained within the inflation target range throughout the period
under review. This is a result of the inflation rates for durable and semi-durable goods
falling to below the lower end of the inflation target range, counteracting the increase in
non-durable goods inflation caused largely by increases in the petrol price. Services
inflation has remained persistently above the target range, although it has been declining
since September 2009.
Table 3
CPI: Goods and services inflation
Percentage change over 12 months

Sep
Oct
Nov
Dec
Jan
Feb
Mar

Source: Statistics South Africa
Monetary Policy Review May 2010
South African Reserve Bank
The inflation rate for administered prices rose significantly from 3,2 per cent in
September 2009 to 12,9 per cent in February 2010, before declining to 11,2 per cent in
March (Table 4). The inflation rate for the regulated component of administered prices
rose from -0,3 per cent in September 2009 to 14,9 per cent in February 2010 and then
moderated to 12,3 per cent in March, largely due to petrol price inflation falling at a
slower pace from September 2009 and rising from December 2009.
The inflation rate for the unregulated component of administered prices remained almost
constant over most of the period, declining marginally from 9,8 per cent in September
2009 to 9,7 per cent in February 2010, before declining to 9,1 per cent in March.
Table 4
Administered prices
Percentage change over 12 months

Sep
Oct
Nov
Dec
Jan
Feb
Mar

Source: Statistics South Africa
The increase in the petrol price (Figure 4) that has impacted on the CPI has, in turn, been
influenced by developments in the international price of crude oil. Crude oil prices have
risen since the lows experienced in December 2008, and the domestic petrol price has
tracked these increases. After recording a 23-month low of 601 cents per litre in January
2009, the price of 95 octane unleaded petrol in Gauteng Province increased to
872 cents per litre in May 2010.
Inflation measured in terms of the year-on-year change in the producer price index (PPI)
for domestic output remained fairly stable from June until October 2009 at rates of
between -4,1 and -3,3 per cent (Figure 5). From November 2009 there has been a slight
acceleration in this measure of price changes, with the inflation rate turning positive in
South African Reserve Bank

Monetary Policy Review May 2010
Cents per litre

Figure 4
South African petrol price

Petrol price (Gauteng 95 octane)

Margin


Source: Department of Minerals and Energy

1 000
1 200

Fuel tax

Basic fuel price

Road Accident Fund

Other levies

December 2009 and more recently recording a level of 3,7 per cent in March 2010. The
main contributors to these movements were the mining and quarrying group, basic metals
and electricity. The year-on-year rate of inflation of the PPI for imported commodities has
risen strongly from -16,3 per cent in September 2009 to 5,8 per cent in March 2010.
Figure 6 plots the year-on-year percentage changes in food prices in the domestic
output PPI and the CPI. PPI food inflation at the agricultural level has remained negative
and somewhat volatile since September 2009, initially rising to -2,1 per cent in October
2009, but subsequently falling to -13,5 per cent in February 2010. PPI food inflation at
the manufacturing level has remained negative since the previous Monetary Policy
Review, although it seems to have levelled off at a level above -2,0 per cent.
Monetary Policy Review May 2010
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Percentage change over 12 months

Details regarding changes to the PPI in this period are documented in statistical release
P0142.1, February 2008, issued by Statistics South Africa
Source: Statistics South Africa
Figure 5
PPI for domestic output and imported commodities
-30
-20
-10

Domestic output
Domestic output: Electricity
Domestic output: Manufacturing
Imported commodities
Percentage change over 12 months
Source: Statistics South Africa
Figure 6
Food prices in the PPI and CPI


PPI: Food at agricultural level
CPI: Food
PPI: Food at manufacturing level

South African Reserve Bank

Monetary Policy Review May 2010
Box 1: Clarification of the Reserve Bank’s mandate

Monetary Policy Review May 2010
South African Reserve Bank
Factors affecting inflation
Monetary policy decisions are made on the basis of current and expected developments
in the wider macroeconomy. Recent developments in some of the main variables
influencing inflation in South Africa are reviewed in this section, while the outlook for
these variables and their likely impact on inflation are discussed in a later section.
International economic developments
The contraction in the global economy in 2009 was less severe than expected,
largely as a result of the better-than-expected positive growth in the final quarter of
the year. The International Monetary Fund (IMF) in its World Economic Outlook (WEO)
– April 2010 estimates that the global economy recorded growth of -0,6 per cent in
2009 compared with 3,0 per cent in 2008 (Table 5). The stronger recovery towards
the end of 2009 was fuelled by an increase in industrial production (and hence a turn
in the inventory cycle), an increase in global trade and stronger-than-expected
demand in the United States (US) and a number of emerging-market economies that
ultimately reflected the extraordinary fiscal and monetary policy measures
implemented worldwide.
The global growth outcome for 2009 reflected contractions in most of the developed
countries, countered by firmly positive growth in emerging and developing countries. For
the US, negative economic growth of 2,4 per cent was recorded for the year 2009
compared with a positive rate of 0,4 per cent in 2008. However, the US experienced
stronger domestic demand and an increase in industrial production, resulting in a
sustained increase in real output during the second half of 2009.
The economy of Japan shrank by 5,2 per cent in 2009, compared with negative real
growth of 1,2 per cent in 2008. For the euro area, negative economic growth of 4,1 per
cent was recorded for the year 2009 compared with positive real growth of 0,6 per cent in
2008. Worries that Greece may default on its mounting debt, destabilising the euro and
sparking a bigger debt crisis amid other vulnerable euro area member states, have
weighed on markets intermittently in recent months. The fears were exacerbated in
April 2010 after Greek borrowing costs spiked to an all-time high, and ratings agencies
South African Reserve Bank

Monetary Policy Review May 2010

downgraded Greek sovereign debt. Standard & Poor’s downgraded Greek debt in late
April, which led to concerns about the euro and the status of other strained European
economies. In the United Kingdom (UK), negative real gross domestic product (GDP)
growth of 4,9 per cent was recorded in 2009 compared with positive real growth of
0,5 per cent in 2008, as further weakening in the housing market continued to impact
negatively on the components of final demand.
Table 5
Annual percentage change in real GDP and consumer prices
Share of
global
Real
Consumer
GDP*
GDP
prices


GDP shares based on the IMF's purchasing-power-parity valuation of country GDPs for 2009
Source: IMF World Economic Outlook, April 2010
The confluence of weaker external demand and lower commodity prices led to weaker
growth outcomes in most emerging economies in 2009. Average growth remained
positive at 2,4 per cent, down from 6,1 per cent in 2008. For developing Asia, IMF data
indicate that real output growth moderated to 6,6 per cent in 2009 from 7,9 per cent in
2008. Growth in both China and India slowed somewhat, albeit from high rates, but
domestic demand continued to be supported by strong policy stimulus. The Chinese
economy recorded growth of 8,7 per cent in 2009, while India’s economy recorded
growth of 5,7 per cent.
Growth in sub-Saharan Africa remained positive in 2009, with an expansion in real GDP
of 2,1 per cent compared with 5,5 per cent in 2008. However, the inflation rate only
declined slightly from 11,6 per cent in 2008 to 10,6 per cent in 2009. In the emerging
and developing countries inflation moderated significantly to 5,2 per cent in 2009, while
in the advanced economies there was virtually no inflation pressure – in fact, deflation
was registered in Japan and the US.
Oil prices
The price of Brent crude oil, which had risen from a low of around US$34 per barrel late
in December 2008 to around US$75 per barrel in early November 2009, remained
Monetary Policy Review May 2010
South African Reserve Bank
relatively stable thereafter, fluctuating in a band of between US$67 and US$89 per barrel
(Figure 7). Over this period the oil price was influenced largely by unexpected weather
patterns in the northern hemisphere, concerns over the Iranian enrichment programme, a
refinery strike in France and the volatility of the US dollar. Price pressure at the upper end
of the band was capped by the recovery in global oil production from the lows recorded in
the second quarter of 2009. However, by early April 2010, oil prices had settled at their
highest level since October 2008, as a weaker US dollar, strong manufacturing data from
China and the euro zone, as well as better-than-expected US unemployment data helped
offset an increase in US crude oil inventories. Economic data reinforced expectations that
a strengthening global economy would boost the demand for crude oil.
At the March 2010 meeting of the Organization of the Petroleum Exporting Countries
(OPEC) it was decided to keep target production at the level of 24,84 million barrels per
day. This decision was taken after considering the fact that the expected increase in
demand for crude oil in 2010 would be more than covered by increased production from
non-OPEC oil-producing countries, that the stock levels in the Organisation for
Economic Co-operation and Development (OECD) countries were comfortably above
their five-year average and that there were still many perceived risks to the global
recovery that could have a negative impact on the demand for oil and hence its price.
International monetary policy developments
The nascent global recovery continues to be supported by short- and long-term
interest rates that have been held at their lowest levels on record in developed
countries. Central bank balance sheets in developed countries expanded rapidly until
recently and many central banks in emerging economies introduced special liquidity or
credit facilities. The significant monetary stimulus in a number of countries is likely to
continue for some time, although in some of these countries increasing emphasis is
being placed on appropriate exit strategies from the extraordinary and unprecedented
crisis-related intervention policies.
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Monetary Policy Review May 2010
Figure 7
Price of Brent crude oil

US dollar per barrel

Brent crude spot price

Futures prices (25 January 2010)

Futures prices (24 March 2010)

Futures prices (Latest: 11 May 2010)
Source: Bloomberg

While global monetary conditions remain accommodative, some central banks have
raised policy rates and even in countries where monetary conditions remain very
accommodative crisis-related liquidity provision is winding down. There is therefore
much reason for optimism about the economic outlook when comparing current
developments with the global outlook scenario in 2009. Table 6 shows that since
September 2009 policy rates have been reduced by central banks in a number of
countries including Denmark, the Czech Republic, Hungary, Russia, Turkey and Iceland.
However, Australia has led the world in raising borrowing costs partly in anticipation of
a surge in investment in new mines and resources that may spark price pressures. Other
countries that have raised policy rates in recent months include Norway, Israel, Malaysia,
India and Brazil. As the recovery in these economies is expected to be stronger than in
most advanced countries, they will probably continue to lead the tightening cycle. China
has also begun tightening monetary policy in recent months in response to rapidly rising
prices and concern about asset price inflation in particular.
Table 6
Selected central bank interest rates
Per cent
Latest decision
(change in
Countries
1 Sep 2009
13 May 2010
percentage points)
0,00–0,25
0,00–0,25
28 Apr 2010
(0,00)
0,10
0,10
10 May 2010
(0,00)
1,00
1,00
6 May 2010
(0,00)
0,50
0,50
10 May 2010
(0,00)
0,25
0,25
20 Apr 2010
(0,00)
1,35
1,05
25 Mar 2010
(0,00)
0,25
0,25
20 Apr 2010
(0,00)
1,25
2,00
5 May 2010
(0,25)
0,00–0,75
0,00–0,75
11 Mar 2010
(0,00)
3,00
4,50
4 May 2010
(0,25)
2,50
2,50
29 Apr 2010
(0,00)
0,75
1,50
26 Apr 2010
(0,00)
5,31
5,31
31 Mar 2010
(0,00)
0,50
0,50
5 Nov 2009
(0,00)
6,50
6,50
5 May 2010
(0,00)
2,00
2,50
13 May 2010
(0,25)
2,00
2,00
12 May 2010
(0,00)
1,25
1,25
25 Mar 2010
(0,00)
1,25
1,25
21 Apr 2010
(0,00)
4,75
5,25
20 Apr 2010
(0,25)
8,75
9,50
28 Apr 2010
(0,75)
0,50
0,50
15 Apr 2010
(0,00)
4,50
4,50
16 Apr 2010
(0,00)
1,25
0,75
6 May 2010
(-0,25)
8,00
5,25
26 Apr 2010
(-0,25)
3,50
3,50
28 Apr 2010
(0,00)
10,75
8,00
29 Apr 2010
(-0,25)
7,75
6,50
13 Apr 2010
(0,00)
12,00
8,50
5 May 2010
(-0,50)
Source: National central banks
Monetary policy remains accommodative in the US and the end of the mortgage buying
programme of the Federal Reserve (the Fed) was received calmly as private markets
increasingly fill the void. The final Term Auction Facility and the Fed’s US$1,25 trillion
mortgage buying programme, with which it commenced during the worst of the credit
crisis to help markets and the economy, ended in March 2010. Further action taken by
the Fed was to increase the primary credit rate charged to banks on short-term loans by
25 basis points in February 2010, while the discount window was shortened to overnight
Monetary Policy Review May 2010
South African Reserve Bank
in order to encourage banks to return to using this facility as a last resort when private
funding is unavailable. The Fed has expressed its confidence that it will be able to drain
reserves from the system effectively and shrink its balance sheet when there are
appropriate signs that the worst has passed and that labour markets are headed in the
right direction. The Fed has kept its benchmark rate close to zero since late 2008 and
confirmed at the most recent Federal Open Market Committee (FOMC) meeting that it
would maintain exceptionally low interest rates for an extended period. The Fed
announced in May 2010 that it would reopen swap lines with other central banks to
ensure that they had sufficient access to US dollars.
The policy rate of the European Central Bank (ECB) remains at a record low level of 1 per
cent. The ECB left the policy rate unchanged at its most recent meeting and announced
new collateral rules that would extend easier lending terms into 2011 to ease financial
conditions for certain member countries in particular, while keeping interest rates at a
record low. After the announcement of the European Union (EU) bailout plan, the ECB
stated that it was willing to purchase euro zone government and private bonds “to ensure
depth and liquidity” in markets.
The Bank of Japan (BOJ) kept its key interest rate unchanged at its most recent meeting.
The overnight call rate has remained at 0,1 per cent since December 2008. However,
policy was loosened further in March 2010 when BOJ board members boosted liquidity
by expanding a low-interest loan programme in a further step to counter deflation.
The Bank of England’s (BOE) Monetary Policy Committee (MPC) held the cost of borrowing
at 0,5 per cent at its most recent meeting and did not alter the £200 billion it had advanced
thus far through quantitative easing to support the UK economy. The BOE warned that the
road back to economic health would be slow and bumpy, given continued strains in the
UK banking system, the need to reduce high levels of debt in both the public and private
sectors, and the weakness of demand for UK exports in the euro area.
Denmark’s central bank reduced its main policy rate twice in January 2010. The
Danmarks Nationalbank cut two of its rates on 25 March 2010 to ease pressure on the
currency, but left its key lending rate unchanged at a record low 1,05 per cent. By cutting
its certificate of deposit and current-account rates, the central bank aimed to curb
currency strength without aligning its main rate with official euro zone borrowing costs.
The central bank has cut its key lending rate 14 times since it began easing from a peak
of 5,5 per cent in late 2008.
Australia’s central bank raised its benchmark interest rate to 4,50 per cent on 5 May 2010.
This represented the sixth increase in borrowing costs in seven meetings, and the central
bank deemed the move a further step towards ensuring a durable recovery by returning
interest rates to average levels. The Reserve Bank of Australia revised its inflation
forecasts upwards, with headline CPI expected to grow at 3,25 per cent in the year to
June 2010, compared with the previous forecast of 3 per cent. Inflation in Australia
reached 2,9 per cent in the quarter to March 2010, up from 1,3 per cent and 2,1 per
cent in the previous two quarters, although it remains within the central bank’s target
range of between 2 and 3 per cent over the cycle.
Policy-makers in India, China and Brazil have joined Australia in withdrawing monetary
stimulus in 2010, seeking to head off asset-price bubbles as the regions lead global growth.
China’s central bank is seeking to slow lending growth by 22 per cent to 7,5 trillion yuan this
year. In March 2010 the World Bank cautioned that China needed to raise interest rates to
help contain the risk of a property bubble and to allow a stronger yuan to dampen inflation.
China’s central bank will sell three-year bills for the first time since June 2008 and has, on
three occasions, ordered banks to increase the share of their assets held in reserve. India
increased interest rates for the first time in almost two years in March 2010, and raised rates
again in April to dampen rising inflationary pressures. Brazil increased the target Selic rate
to 9,5 per cent from the end of April 2010 due to concerns about rising inflation.
South African Reserve Bank

Monetary Policy Review May 2010

Exchange rate developments
The foreign-exchange rate of the South African rand has generally strengthened in the
period since the publication of the November 2009 Monetary Policy Review, although it
has eased somewhat in recent weeks as a result of renewed risk aversion following the
escalation in the Greek sovereign debt crisis (Figure 8). The trend appreciation of the
rand was attributable to higher commodity prices (notably, gold and platinum prices),
abnormally and persistently low interest rates in advanced economies, and inflows into
the domestic bond and equity markets. To date in 2010, non-resident net purchases of
South African bonds and equities have totalled around R43 billion, compared with net
sales of R76 billion in the second half of 2008 and net purchases of R91 billion for 2009.
The nominal effective exchange rate (NEER), which measures the value of the rand
against a basket of 15 currencies, appreciated by 14 per cent from around 67 index
points early in November 2009 to 76,4 index points on 7 April 2010. It then depreciated
to 73,2 index points on 7 May, before recovering to 75,1 index points on 11 May.
Measured on a bilateral basis, the rand appreciated from R11,68 to R9,59 against the
euro between 3 November 2009 and 11 May 2010. Over the same period, the rand
appreciated from R7,92 to R7,53 against the US dollar.
South Africa’s real exchange rate has also appreciated in recent months. Measured by
the Bank for International Settlements (BIS), on a consistent basis with other countries,
it increased from around 70 index points at the end of 2008 to 96,3 index points in
March 2010 (Figure 9). This appreciation is in line with that of other commodity-exporting
countries such as Australia, Canada and Brazil, although the South African real
exchange rate is the only one of this group that remains below the levels recorded, on
average, in the 2005 base year.
Monetary Policy Review May 2010
South African Reserve Bank
Index: 2000 = 100 (foreign currency per rand)
Rand per euro
Rand per US dollar
Figure 8
Exchange rates of the rand

M
M
J
S
N
J

J
M
M
J
S
N
J
M
M
M
M
J
S
N
J

Nominal effective exchange rate of the rand (NEER)

Rand per US dollar

Rand per euro (right-hand scale)

Labour markets
Figure 10 shows that the year-on-year change in unit labour cost, which had declined
from mid-2008, increased from 5,7 per cent in the third quarter of 2009 to 8,8 per cent
in the fourth quarter. Wage inflation, measured by the year-on-year rate of increase in the
nominal remuneration per worker in the non-agricultural sectors, rose from 7,8 per cent
in the third quarter of 2009 to 12,3 per cent in the fourth quarter, largely as a result of
one-off salary adjustments in the public sector. This increase was not fully offset by the
improvement in the year-on-year rate of increase in labour productivity, which rose from
0,3 per cent in the second quarter of 2009 to 2,0 per cent in the third quarter and
3,1 per cent in the fourth quarter.
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Monetary Policy Review May 2010
Indices: 2005 = 100

Figure 9
Real effective exchange rates

Source: Bank for International Settlements
Australia
Brazil
Canada
South Africa
Percentage change over four quarters

Figure 10 Remuneration per worker, labour productivity and

unit labour cost in the formal non-agricultural sector

Nominal unit labour cost

Remuneration per worker

Labour productivity


Sources: Statistics South Africa and South African Reserve Bank calculations
-2

According to the outcome of the Andrew Levy Wage Settlement Survey, the level of
wage settlements amounted to 8,4 per cent in the first quarter of 2010, after averaging
9,3 per cent in 2009 and 9,8 per cent in 2008. The settlements in the first quarter of
2010 ranged from 7 per cent in the health/education sector to 10 per cent in the retail
sector. In 2009 the settlements ranged from 5 per cent in the paper/printing sector to
12,3 per cent in the food/agriculture sector, with 55,6 per cent of settlements falling in
the 9–10,9 per cent band (Figure 11).
Demand and output
The South African economy began to recover in the period under review. Having
contracted in the previous three quarters on a quarter-on-quarter basis, real GDP
increased at annualised rates of 0,9 per cent in the third quarter of 2009 and 3,2 per cent
in the final quarter of the year (Table 7). For the year as a whole, real GDP nevertheless
contracted by 1,8 per cent in 2009, compared with growth of 3,7 per cent in 2008.
The primary, secondary and tertiary sectors all contributed positively to the growth in real
GDP in the fourth quarter of 2009. The real value added by the primary sector increased
by 0,9 per cent in the fourth quarter, following a decline of 7,6 per cent in the third
quarter. This was the result of positive growth in mining production and a slower rate of
contraction in the agricultural sector. In the secondary sector, growth increased from
7,0 per cent in the third quarter of 2009 to 8,1 per cent in the fourth, mainly as a result
of a further acceleration in growth in manufacturing output. Finally, growth in the real
value added by the tertiary sector rose from 0,8 per cent in the third quarter of 2009 to
2,3 per cent in the fourth quarter, with increased activity recorded in all the subsectors
of the sector.
Monetary Policy Review May 2010
South African Reserve Bank
Per cent

2010*
Figure 11 Average annual inflation and wage settlements

CPI

Average wage settlements
* Data for 2010 are for the first three months of the year
Sources: Andrew Levy Employment Publications and Statistics South Africa
-2

Table 7
Growth in real GDP and expenditure components
Per cent*

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

Quarterly data refer to quarter-on-quarter growth at annual rates of seasonally adjusted data
**
Constant 2005 prices
Real gross domestic expenditure increased at a rate of 5,0 per cent in the final quarter
of 2009, after declining by 10,8 per cent in the second quarter and 1,6 per cent in the
third quarter. This performance was the result of a recovery in growth in final
consumption expenditure by households over the period, and a turnaround in changes
in real inventory levels and gross fixed capital formation (Figure 12). Final consumption
expenditure by households increased at a rate of 1,4 per cent in the final quarter of the
year, although the annual growth rate for 2009 reflected a contraction of 3,1 per cent.
Growth in final consumption expenditure by general government slowed to 2,3 per cent
in the fourth quarter from 8,1 per cent in the third quarter.
South African Reserve Bank

Monetary Policy Review May 2010
Percentage change from quarter to quarter

Figure 12 Gross domestic expenditure

Final consumption expenditure by households

Final consumption expenditure by general government

Gross fixed capital formation

Change in inventories

Residual item

Gross domestic expenditure

-15
-10
-5

In the external sector of the economy, real exports of goods and services grew by an
annualised 11,0 per cent in the third quarter of 2009 and by 20,0 per cent in the final
quarter. Real imports of goods and services rose at an annualised rate of 26,2 per cent
in the fourth quarter after declining by 1,0 per cent in the third quarter. South Africa’s
trade surplus with the rest of the world consequently widened from R22,3 billion in the
third quarter of 2009 to R24,9 billion in the fourth quarter. Since net service, income
and current transfer payments to non-residents remained broadly constant in the
second half of 2009, the deficit on the current account of the balance of payments
declined steadily from 6,7 per cent of GDP in the first quarter of 2009 to 2,8 per cent
in the final quarter.
South Africa’s gross gold and other foreign reserves rose from US$39,1 billion at the end
of September 2009 to US$42,3 billion at the end of April 2010. The international liquidity
position increased from US$37,9 billion to US$38,5 billion over the same period. The
reserve positions were influenced by revaluation effects due to the stronger foreign
exchange rate of the US dollar over the period, as the Bank continued to be a net
purchaser of foreign currency.
Real-estate and equity prices
Both real-estate prices and the prices of shares on the JSE Limited (JSE) have
recovered from the low levels seen in early 2009. Since the first quarter of 2009, JSE
share prices have risen strongly, driven by the recovery in global markets and the
improving global economic outlook, improved investor sentiment towards South Africa
by overseas investors and firmer commodity prices. The FTSE/JSE All-Share Index (Alsi)
increased by 63 per cent from a low of 18 121 index points on 3 March 2009 to a peak
of 29 565 index points on 15 April 2010, before declining in line with international
markets to 26 515 on 7 May following concerns about Greece’s sovereign debt. By 11
May it had recovered to 27 514 index points. The index performed similarly to those of
Monetary Policy Review May 2010
South African Reserve Bank
Indices: 1 January 2007 = 100

FTSE/JSE All-Share Index
United States (S&P 500)
Euro area (DJ Euro Stoxx 50)
Japan (Nikkei 225)
Figure 13 Share price indices

Brazil (Bovespa)
India (Bombay Sensitive)
Malaysia (Kuala Lumpur Composite)
China (Shanghai A Share)
Sources: JSE Limited and I-Net Bridge
other emerging-market economies such as Malaysia, China and India, increasing less
than the Brazilian Bovespa Index but outperforming the S&P 500, Dow Jones Euro
Stoxx50 and the Nikkei indices (Figure 13).
The year-on-year percentage changes in nominal house prices have returned to positive
territory, after recording negative rates in most of 2009 (Figure 14). Factors contributing
to the upward trend include the lagged effect of the cumulative 550 basis point reduction
in interest rates since 2009, the easing of lending conditions to consumers by banks and
growing optimism about the impact of improving economic growth on household
disposable income. The 12-month change in the First National Bank (FNB) National
Average House Price Index improved from -6,9 per cent in May 2009 to 10,1 per cent
in April 2010, and a similar upward trend is evident in the Absa House Price Index, which
improved from a rate of -3,7 per cent in May 2009 to 13,5 per cent in April 2010. The
12-month change in average house prices measured by the Standard Bank Median
House Price Index improved from -5,2 per cent in September 2009 to
2,0 per cent in April 2010.
Building statistics published by Statistics South Africa summarised in Table 8 show a
deterioration in the total real values of both building plans passed and buildings
completed in the past three years. The pace of contraction measured by the annual
percentage changes of the total real value of building plans passed deteriorated from
-2,4 per cent in 2007 to -21,6 per cent in 2009. Similarly, the growth in the total real
value of buildings completed and in residential buildings completed deteriorated from
positive rates in 2007 to negative rates in 2009. The deterioration in the residential
components of both building plans passed and completed was more intense in 2009
than in 2008.
South African Reserve Bank

Monetary Policy Review May 2010
Percentage change over 12 months

-10
-5

Absa House Price Index

Standard Bank House Price Index

First National Bank House Price Index
Sources: Absa, Standard Bank and First National Bank
Figure 14 House prices

Table 8
Real value of building plans passed and buildings completed in
larger municipalities
Annual percentage change

2010*
Building plans passed

Buildings completed

Data for 2010 are for the first two months of 2010 compared with the same period of the previous year
Source: Statistics South Africa
Fiscal policy
The fiscal space that was created in the years preceding the financial crisis allowed a
concerted response to the crisis in line with government’s stated intention to manage
public finances along a trajectory that will return the fiscus to a sustainable position. The
2010 Budget that was presented by the Minister of Finance on 17 February 2010
maintains public spending levels, while revenue is projected to recover over the forecast
period to 2012/13. The deficit is therefore projected to continue trending downwards as
spending growth moderates and revenue continues to rise. Over the next three years
public spending is projected to grow by about 2 per cent on average in real terms
compared with average real growth of 7,2 per cent in the preceding three years. Noninterest expenditure is projected to decline over the forecast period and rising budget
revenue will lead to a narrowing primary budget deficit over the next three fiscal years.
The revised budget balance for 2009/10 is a deficit of R177,8 billion, which represents
7,3 per cent of GDP (Table 9). This revised budget balance is almost double the deficit of
3,8 per cent of GDP projected in the Budget Review 2009. Consolidated government
revenue reflects the impact of lower earnings, and reduced consumption and imports on
tax revenues, and is expected to have amounted to R657,6 billion in 2009/10, significantly
lower than the estimate of R740,4 billion made in February 2009. Consolidated
government expenditure in 2009/10 was expected to have been approximately as
projected in February 2009, rising marginally from R834,3 billion to R835,3 billion. In the
medium term, projected deficits as a percentage of GDP are 6,2 per cent for 2010/11,
declining to 5,0 per cent for 2011/12, and to 4,1 per cent for 2012/13.
The estimated public-sector borrowing requirement (PSBR), reflecting the higher
financing requirements of government and the non-financial public enterprises, is
expected to widen to 11,8 per cent of GDP in 2009/10. While the deficits of government
and the non-financial public enterprises are projected to moderate in subsequent years
– declining to 11,1 per cent of GDP in 2010/11, to 8,8 per cent of GDP in 2011/12 and
to 7,1 per cent of GDP in 2012/13 – total borrowing of the public sector remains high
over the medium term. Net loan debt as a share of GDP in 2009/10 has been revised
to 28,2 per cent and is projected to increase to 39,8 per cent of GDP by 2012/13.
Based on National Treasury’s GDP growth estimates, the central forecast is for net loan
debt to rise to 44 per cent of GDP in 2015/16 and to decline gradually thereafter. While
the assumptions produce a reasonably favourable fiscal outlook, lower economic
growth outcomes and higher fiscal deficits pose significant risks to the outlook.
Monetary Policy Review May 2010
South African Reserve Bank
Table 9
Public finance data

Revised
Outcome
Budget
estimates
Medium-term estimates
Consolidated national
government* (R billions)

As a percentage of GDP

Includes national government, provinces, social security funds and selected public entities
**
PSBR: Public-sector borrowing requirement
Source: National Treasury Budget Review 2010
Monetary conditions
Growth in broad money has generally declined since September 2009, with growth in
the M3 aggregate recording a record-low year-on-year rate of 0,1 per cent in
February 2010, before rising to 1,6 per cent in March (Figure 15). The growth rate of M2
has been somewhat volatile, recovering to 0,2 per cent in January 2010, contracting by
1,2 per cent in February and recording 0,2 per cent in March. Conversely, the growth
rate of M1 has continued to rise since previously reported in the November 2009
Monetary Policy Review. The growth rate increased from 1,2 per cent in September
2009 to 11,5 per cent in March 2010.
As Figure 16 shows, year-on-year growth in the total loans and advances aggregate has
remained negative since September 2009, reaching a low of -1,6 per cent in November
2009 and most recently contracting by 0,3 per cent in March 2010. Mortgage advances,
which grew by 3,9 per cent in January and February 2010, have levelled off since
October 2009. All other categories of loans and advances to the private sector remain
South African Reserve Bank

Monetary Policy Review May 2010
Percentage change over 12 months

Figure 15 Growth in monetary aggregates
-10
-5

M3
M1
M2

in negative growth territory, although there are some signs that the trajectory of the
growth paths may have changed in line with continued lower interest rates, increased
economic activity, and improving consumer and business confidence.
Monetary Policy Review May 2010
South African Reserve Bank
Box 2 Exchange rate pass-through in South Africa: Panel evidence from
individual goods and services
Exchange rate pass-through is broadly defined as the percentage change in prices as a result of a
change in the exchange rate. However, this definition contains a considerable amount of ambiguity,
and there are a number of issues that complicate the measurement of exchange rate pass-through.
The prices considered, the lag between exchange rate changes and prices changes, the source of
the exchange rate change, the presence of simultaneity biases and possible changes in aggregate
price indices are all potentially important. Recent work undertaken at the Bank contributes to this
literature by studying exchange rate pass-through in South Africa at a disaggregated level.1 Two
distinct panels of disaggregated data are employed. The first data set, obtained from the Economist
Intelligence Unit (EIU), contains annual prices of 158 individual goods and services at the consumer
level from 1990 to 2009. The second panel contains quarterly average import unit values for 26 eightdigit import categories from ten of South Africa’s top trading partners from the first quarter of 1998 to
the second quarter of 2009. Estimates of pass-through to both sets of prices are reported in the
study.
Focusing first on pass-through to prices in the EIU data set, a number of specifications are
estimated. The basic specification is a first-differenced log linear specification of the standard
exchange rate pass-through equation:
Δp*it = ∑1j=0 bj Δst-j + cΔct + dΔrgdpt + sΔG7gapt + goods dummies
where Δ is the first-difference operator, p*it is the natural log of the rand price of the good or service i
at time t, st-j is the log of the bilateral rand/US dollar exchange rate at time t-j, ct is the log of the world
export price index – an indicator of costs of production, rgdp is log real gross domestic product – an
indicator of changes in domestic demand conditions, and the G7 output gap is indicated by G7gap.
Since the goods are pooled into a single regression, product dummies are included.
The second specification builds on this by including lags of exogenous variables and a lag of the
dependent variable, the third specification includes an error correction term to capture reversion to
purchasing power parity (PPP)2, and the final specification includes interaction terms of the trend
with the error correction term and the change in the exchange rate term.

Parsley D. 2010.
“Exchange Rate Pass-through
in South Africa: Panel Evidence
from Individual Goods and
Services”. Forthcoming, South
African Reserve Bank Working
Paper.

The PPP relationship is
obtained from a regression of
South African consumer prices
on United States prices, the
nominal rand/dollar exchange
rate and a constant.
Percentage change over 12 months

-20
-10

Figure 16 Banks' loans and advances by type

Mortgages

Instalment sale and leasing finance

Credit card advances

General advances

Overdrafts

Total loans and advances
South African Reserve Bank

Monetary Policy Review May 2010
Each specification is estimated separately for those items designated as goods (113 items) and for
those items designated as services (45 items), a unique aspect of the study. The main results are
summarised in Table B2.1. As can be seen, short-run pass-through is statistically significant for all
specifications using the goods data set, and all but one specification for the services data set.
Short-run pass-through is quite low, ranging between 11 and 23 per cent for goods and between
10 and 37 per cent for services. It can also be seen that pass-through from the change in the
foreign prices of goods is somewhat higher than the exchange rate pass-through for both goods
and services. These results confirm that the law of one price does not hold. The error correction
term is significant in both specifications for the goods data set and for the third specification for the
services data set. While this indicates long-run reversion to PPP, the long run is particularly long,
which suggests that either prices are sticky in South Africa or that there is significant local valueadded content in goods and services sold to the consumer in South Africa. The finding that there
is no significant trend in exchange rate pass-through may explain why there has been less of a
downward trend in inflation in South Africa relative to the results of studies for other countries.
Table B2.1
Pass-through to final goods and services

Goods

Services

***, **, * indicate significance at the 1, 5 and 10 per cent levels respectively
Pass-through to import prices is estimated using the import unit values of 26 products imported
into South Africa, from the ten largest suppliers, that is, using a three-dimensional panel of goods
(26), countries (10) and time (46 quarters). Following Knetter (1989), the following general empirical
specification is used:
In p*ijt = it + mj + ci + bj In sjt + oijt
According to this specification, the rand price of import i, is determined by good, time and source
country fixed effects, plus a random error. Augmenting the equation with country specific (log)
exchange rates allows an estimate of the country-specific pass-through elasticities, which is
presented in Table B2.2.

Monetary policy
In the wake of the global financial crisis, many central banks have loosened their monetary
policy significantly. Most of these adjustments occurred during late 2008 and the first half
of 2009. South Africa generally followed this trend, and between December 2008 and
August 2009 the repurchase rate was reduced by a total of 500 basis points. The stance
of monetary policy subsequently remained unchanged until March 2010. During this
period, the MPC was of the view that the repurchase rate was consistent with the
expected inflation trajectory and with the projected recovery in the domestic economy.
Since the publication of the previous Monetary Policy Review (November 2009), the
repurchase rate was reduced by a further 50 basis points in March, which brought it to a
level of 6,5 per cent per annum (Figure 17). This further reduction in the rate was
implemented against the backdrop of a more favourable inflation outlook and continued
weakness in domestic household consumption expenditure in particular.
In 2009, against the backdrop of heightened volatility and uncertainty in international
financial markets, and the severe global economic downturn, the decision was taken to
increase the frequency of MPC meetings to monthly, given the pace at which global
Monetary Policy Review May 2010
South African Reserve Bank
Table B2.2
Pass-through to South African imports


***, **, * indicate significance at the 1, 5 and 10 per cent levels respectively
The first set of results reported in Table B2.2 is based on the entire data set, while the second set
of results is from regressions run after dropping the top and bottom 5 per cent of the residuals.
These results suggest that pass-through from Brazil and the US is quite high, at over
70 per cent (column 1). Furthermore, pass-through from Germany, Great Britain, India, Switzerland
and Taiwan is clustered around 60 per cent, while Japan exhibits a much lower level of passthrough at about 38 per cent. The results for China and Sweden report low levels of pass-through,
although the coefficients are not significantly different from zero. The results reported in column 2 are
quite similar to those reported in column 1, except that pass-through from China becomes
statistically significant at the 5 per cent level.
Finally, two additional specifications were estimated using this data set. The first constrains all passthrough coefficients to be the same (excluding China and Sweden) and the second investigates if
the level of the pass-through has changed over time. The results suggest that the average passthrough to South African import prices over the period 1998 to 2009 is about 60 per cent and that
there is no evidence that the level of pass-through to import prices has changed over time.
Results from this study suggest that pass-through to prices estimated using the EIU data set is low
in South Africa (between 15 and 25 per cent) and that there is very slow convergence to long-run
purchasing power parity. No evidence of a decline in pass-through to these prices over the past
twenty years was found in this study. Furthermore, pass-through to import prices is somewhat
higher at around 60 per cent and no evidence of decline over the estimation period was found.
events were unfolding. This allowed for a more timely assessment of, and appropriate
reaction to, new information and changing circumstances. However, as the intensity of
the crisis declined and it appeared that the global economy was on the road to recovery,
the Bank reverted to a bimonthly schedule, although it was noted that this schedule
could be reconsidered if the situation called for it. During the period under review, there
have been three meetings of the MPC: in January, March and May 2010.
At the time of the January 2010 meeting, the most recent inflation outcomes were within
the inflation target range. Year-on-year CPI inflation rates for October and November 2009
measured 5,9 per cent and 5,8 per cent respectively, although there was an expectation
that inflation would temporarily breach the upper end of the target range as a result of
adverse technical base effects related to petrol prices in particular. At that stage, it was
expected that inflation would increase to around 6,5 per cent in December 2009 and
January 2010, before returning on a sustained basis to within the inflation target range by
March 2009. The MPC emphasised that the forward-looking nature of monetary policy
meant that the focus remained on the longer-term expected trend of inflation and, at that
stage, inflation was expected to remain within the inflation target range until the end of the
forecast period in the final quarter of 2011, when it would measure around 5,4 per cent.
Inflation declined to within the inflation target range sooner than expected. In February 2010
inflation measured 5,7 per cent and declined further to 5,1 per cent in March. In March the
Bank’s forecast indicated an improved inflation outlook for 2010, compared with the
previous forecast, while the forecast for 2011 was relatively unchanged.
At the May 2010 meeting, there was further improvement in the forecast, with inflation
expected to reach a low point of 4,7 per cent in the third quarter of 2010. Inflation was
then expected to increase moderately and remain within the inflation target range until
the end of the forecast period, which had been extended to the end of 2012, at 5,3 per
cent. This forecast is discussed in more detail in a later section.
Inflation expectations, as reflected in the survey conducted by the Bureau for Economic
Research (BER) at Stellenbosch University had remained persistently high during 2009
South African Reserve Bank

Monetary Policy Review May 2010
Per cent

Prime overdraft rate
Repurchase rate
Three-month negotiable certificates of deposit rate
Figure 17 The repurchase rate and other short-term interest rates

despite the decline in inflation. The 2009 fourth quarter survey continued this trend, but by
March, with the publication of the 2010 first quarter survey, it was evident that there was a
significant improvement and expectations for 2010 inflation declined from 7,7 per cent to
6,5 per cent, while expectations for the subsequent two years moderated to 6,7 per cent
and 6,8 per cent respectively. Despite the improvement, average expectations remained
outside the inflation target range. Expectations of financial analysts, both in the BER survey,
as well as those reflected in the Reuters surveys, were more positive and indicated that the
expectations of this category were anchored at the upper end of the target range.
Domestic economic prospects are strongly influenced by the global economic outlook.
During the period under review, the global economy initially showed signs of a strong
recovery, although this improvement was uneven across regions. The global growth
recovery was driven by emerging markets, particularly in Asia, but the MPC expressed
concern about the low growth and risks in the euro area and, to a lesser extent, in the US.
The committee noted that the relatively slow pace of recovery in advanced economies
implied that the pace at which accommodative monetary policy was reversed was likely to
be slow, while the need to reverse unsustainable fiscal positions posed a risk to the global
outlook. By May, as the crisis in the euro area intensified, these risks increased, and the
MPC noted the possibility of a renewed crisis that could threaten the global recovery.
Despite the massive interventions of European governments, the ECB and the IMF, risks
and uncertainties still prevailed. The global inflation outlook was assessed as being benign
and did not appear to pose a risk to the domestic inflation outlook.
The domestic economy emerged from the recession during this period. By the time of
the January meeting, it was evident that positive growth was being experienced, with
GDP growth of 0,9 per cent recorded in the third quarter of 2009. At that stage, the
Bank’s forecast was that growth in 2010 would average 2,0 per cent. By March, the
growth performance and outlook had improved, following the 3,2 per cent growth rate
recorded in the final quarter of 2009. The Bank’s growth forecast for 2010 also showed
a marked improvement to 2,6 per cent. By May the forecast had improved further to
2,7 per cent and to 3,6 per cent for 2011. The GDP forecasts are discussed in more
detail in a later section. The output gap, which is the difference between actual and
potential output growth, nevertheless remained relatively wide and was expected to
remain positive for some time.
During the period under review, most of the short-term indicators reflected a
continuation of the positive growth trend. The South African Reserve Bank composite
leading indicator confirmed the sustained nature of the upswing and the Kagiso
Purchasing Managers’ Index was also consistent with the observed recovery in the
manufacturing sector, which showed consistent improvement during this period.
Despite the improved growth outlook, the MPC noted the continued weakness in
domestic expenditure and expressed the view that demand conditions did not pose a
risk to the inflation outlook. In the January meeting the committee noted that real
household consumption expenditure was still contracting in the third quarter of 2009,
but by the fourth quarter this trend was reversed when positive, but low, growth was
recorded. There was also evidence that the negative trend in the consumption of
durable goods had reversed. This was reinforced by the strong recovery in motor vehicle
sales that was evident in the first few months of 2010. Retail sales data, despite some
signs of improvement, reflected continued weakness of household consumption
expenditure. In May it was noted that although retail sales declined on a year-on-year
basis in February, when the three months to February were compared with the previous
three months, a positive increase was recorded.
Monetary Policy Review May 2010
South African Reserve Bank
Throughout most of this period, the committee was of the view that the subdued
consumption expenditure was likely to persist as a result of a number of factors. These
included trends in credit extension, the need to repair impaired household balance
sheets and elevated rates of unemployment.
Credit extension by banks to the private sector contracted in most of the categories.
However, these trends were not only a result of strict credit criteria applied by banks, but
also due to constrained demand for credit. The MPC pointed to evidence of some
relaxation of these credit criteria, yet most categories of private-sector credit extension
contracted consistently during this period. Mortgage advances was the only category to
exhibit year-on-year growth, but even this growth was negative in real terms. The decline
in credit extension did help to retard the pace of increase in household debt. The ratio
of household debt to disposable income appeared to have levelled out during this period
after sustained increases in previous years, but remained at historically high levels.
There were, however, some positive developments with respect to wealth effects. Equity
prices continued their steady recovery, but reacted adversely to the global financial
market turbulence in the first week of May. House prices, which had been generally
declining for some time, began to exhibit positive growth.
In January the MPC noted that adverse employment trends and employment insecurity
were likely to constrain household expenditure. During the third quarter of 2009, the
Quarterly Employment Statistics Survey showed further employment losses, despite the
turnaround in the economy. At the March meeting, by which time the fourth quarter data
had been released, a more favourable picture was evident and it appeared that the
decline in employment had slowed. However, the Quarterly Labour Force Survey
released ahead of the May meeting indicated that the unemployment rate had increased
further and that employment trends were likely to lag the recovery.
Fiscal policy has a potentially significant impact on monetary policy. For a number of
years fiscal policy had been supportive of monetary policy and was therefore not a
concern. In response to the crisis, however, the fiscal deficit was allowed to widen as
the automatic stabilisers took effect. The MPC deemed this an appropriate
countercyclical policy and expressed the view that if the proposed fiscal consolidation
over the coming years were to be maintained, it did not foresee a possible conflict with
monetary policy objectives.
A major contributor to the favourable inflation outlook was the behaviour of the rand
exchange rate. During the period under review, the rand exchange rate was generally in
a range of around R7,20 to R7,60 against the US dollar. The uncertainty in the global
financial markets in May resulted in a brief, but significant, depreciation of the rand
against the US dollar. The MPC was, however, cognisant of the fact that a strong rand
could impact adversely on some sectors of the economy and be a cause for concern
from the perspective of overall macroeconomic balance. However, the rand exchange
rate was influenced by a number of exogenous factors, including improved commodity
prices and the sustained capital inflows into emerging markets in general, in response
to abnormally low interest rates in advanced economies. These low interest rates were
expected to persist for some time. Whereas previously the exchange rate was seen as
an upside risk to the inflation outlook, during this period it was generally regarded as a
downside risk. However, the reaction of the rand to the developments in the euro area
demonstrated the vulnerability of the rand to changes in global sentiment, and the MPC
noted that the positive impact of the rand on the inflation outlook was contingent on
developments in the euro area and general risk aversion.
South African Reserve Bank

Monetary Policy Review May 2010

Supply-side factors no longer imparted a major upside risk to the inflation outlook. During
2008 and much of 2009, food price inflation was generally the most significant contributor
to the inflation outcomes. However, during 2009 food price inflation moderated
s i g n i f i c a n t l y. In January 2010 the MPC noted that pre s s u res from food prices had subsided
despite higher international prices. By the March meeting, food price inflation had declined
to below the average CPI inflation rate and the significant decline in the price of maize in
the early months of 2010, and continued price declines at the producer price level
i m p roved the outlook for favourable food price inflation trends in the medium term.
International oil prices recovered somewhat in the course of 2009, but the impact on
domestic inflation was cushioned to some extent by the appreciation of the rand
exchange rate. The petrol price was therefore not regarded as a major upside risk to the
inflation outlook during the period under review, although by the May meeting,
international oil prices had increased somewhat compared with the relatively stable
trading range of US$70 to US$80 that had prevailed for some months.
The trend in wage settlements is also an important focus of the MPC. During this period
the committee noted that the risk to the inflation outlook emanating from wage
developments had subsided somewhat. Although wage settlements were, on average,
still in excess of inflation, indications were that they were declining in nominal terms.
However in May the MPC noted that while nominal wage settlement rates had been
declining, a number of wage negotiations were at levels well above the current and
expected inflation rate. It was noted that should a general upward trend in wage
settlement rates transpire, in the absence of compensating increases in productivity, it
could pose an upside risk to the inflation outlook.
The main risk to the inflation outlook remained administered prices, particularly electricity
price increases. During this period, Eskom had applied for multi-year electricity tariff
increases of 35 per cent per annum. The Bank’s forecasts made provision for 25 per
cent and this imparted an upside risk to the inflation forecast. However, once the
determination of 25 per cent was announced, the upside risk from this source was
reduced. Nevertheless, these tariff increases will remain a source of upside pressure in
the inflation outlook. The committee also noted with concern the apparent trend toward
greater reliance on high tariff increases to fund long-term infrastructure projects.
At the January meeting, the risks to the inflation forecast were assessed as being fairly
balanced. Given that the inflation trajectory was relatively close to the upper end of the
inflation target range, the MPC decided that it would be prudent to keep the repurchase
rate unchanged. By the March meeting, the inflation forecast had improved somewhat
and the risks to the outlook had moved to the downside. This was mainly a result of the
further strengthening of the rand exchange rate and the fact that there was now greater
certainty with respect to electricity tariff increases, which had previously been the main
source of upside risk. In the absence of significant demand pressures and in the light of
this reduced risk, the MPC decided that there was some space for an additional
monetary policy stimulus to re i n f o rce the sustainability of the upswing without
jeopardising the achievement of the inflation target. Accordingly, the repurchase rate
was reduced by a further 50 basis points to 6,5 per cent per annum.
At the May meeting, the risks to the inflation forecast were more evenly balanced. The main
risks to the forecast were seen to emanate from administered prices and the risks
emanating from the global economy. The MPC was of the view that the current stance of
monetary policy was appropriate for the prevailing inflation outlook and associated risks.
The committee accordingly kept the re p u rchase rate unchanged at 6,5 per cent per annum.
Monetary Policy Review May 2010
South African Reserve Bank
The outlook for inflation
The outlook, risk and uncertainties relating to some of the factors that determine the
outlook for inflation are presented in this section.
International outlook
Recent data seem to point towards an improving global economic recovery. Although
projected medium-term growth in the global economy may be somewhat lower than in
previous expansions, the IMF has, in its April 2010 WEO, forecasted a recovery that is
slightly more robust than previously expected. The current upturn in global economic
growth is still largely driven by strong output growth in emerging-market economies,
especially Developing Asia, but the contribution from advanced economies has
improved significantly in recent quarters. The support provided by inventory rebuilding
could, however, soon begin to wane and the sustainability of the global recovery would
then depend, to a large extent, on domestic final demand components such as
consumption expenditure and gross fixed capital formation.
In response to the downturn, monetary policy has been highly expansionary and has
been supported by unconventional liquidity provision, while fiscal policy has provided a
major stimulus in most countries. While financial systems are being repaired in some
countries, the economic recovery will remain fragile in many advanced economies. This
exposes governments to substantial execution risk in the implementation of their exit
strategies. Governments face a delicate balancing act with respect to the timing of these
adjustments and tightening fiscal policy too soon risks undermining the recovery.
However, the IMF notes that postponing fiscal consolidation for much longer is no less
risky as it would test the patience of the market and could force central banks to
commence with pre-emptive monetary policy tightening.
In most developed countries, the negative feedback loops between consumer demand
and financial markets have reversed and pent-up demand has begun to filter through to
the real sector. However, the largest economies plan to maintain the fiscal stimulus
provided in 2009, at least through 2010, as it is expected that the recovery under way
in these countries will be relatively sluggish compared with recoveries from previous
recessions. Although the recoveries in real and financial activity are mutually supportive,
access to credit remains difficult in many countries. According to the IMF, international
policy co-ordination is essential in ensuring a durable recovery and it projects that global
growth will reach 4,2 per cent in 2010 (an upward revision of about 1 percentage point
from the October 2009 estimate) and 4,3 per cent in 2011 (Table 10).
The increase in real GDP in advanced economies during recent quarters was largely
driven by positive contributions from inventory investment and by net exports. Personal
consumption expenditure also contributed significantly to growth in key advanced
economies in the fourth quarter of 2009. The IMF’s April 2010 WEO projects growth of
3,1 per cent for the US economy in 2010, before declining to 2,6 per cent in 2011.
Although the recovery of the US economy gained momentum in the fourth quarter of
2009 with real GDP advancing by 5,6 per cent, private final demand was still subdued
and remained well below pre-crisis levels.
Economic growth in the euro area slowed to 0,2 per cent in the final quarter of 2009 as
consumption remained subdued, while investment contracted. The weakening financial
situation of many euro area countries, in particular Greece, is deemed to be hampering
growth prospects for the region. The IMF projects growth of 1,0 per cent for the euro
area in 2010 and 1,5 per cent in 2011. In May 2010 the EU agreed on a significant
€750 billion bailout plan in an effort to counter a burgeoning sovereign debt crisis that
South African Reserve Bank

Monetary Policy Review May 2010

began in Greece, but subsequently threatened the stability of financial markets worldwide. The plan consists of €440 billion of loans from euro zone governments,
€60 billion from an EU emergency fund, and €250 billion from the IMF.
Table 10
IMF projections of world growth and inflation for 2010 and 2011*
Per cent
Real GDP
Consumer prices


IMF projections for 2010 as at October 2009 in parenthesis
Source: IMF World Economic Outlook, April 2010
Real output in Japan rebounded and expanded at a revised rate of 3,8 per cent in the
fourth quarter of 2009. The BOJ’s quarterly Tankan survey of business sentiment
showed improving sentiment among the nation’s biggest firms for the fourth straight
quarter amid growing faith in the global recovery. The IMF projects growth of
1,9 per cent for Japan in 2010 and 2,0 per cent in 2011. This improvement in growth is
projected to be relatively broad-based with a strong positive contribution from exports.
Deflationary pressures are expected to continue to pose a significant challenge to policymakers in Japan in 2010 and 2011.
The UK finally returned to positive growth with real GDP increasing by 1,8 per cent in the
fourth quarter of 2009, following six consecutive quarters of contraction – the longest
and deepest recession in the UK in the post-war period. The IMF projects growth of
1,3 per cent for the UK in 2010 and 2,5 per cent in 2011.
Emerging-market economies have continued to experience stronger economic growth
since the second half of 2009. Much of the improvement has been the result of
increased trade, robust private consumption expenditure and, for some economies, the
commodity price recovery. Since rebounding in the first quarter of 2009, real GDP
growth in emerging-market economies has continued to strengthen following the
recovery in the global economy. However, domestic structural rigidities coupled with the
uncertainties surrounding economic developments in advanced countries pose the
major risks to growth prospects in emerging countries. Some concern has also been
expressed as to the risk carried by emerging economies as a result of the exceptional
growth of capital inflows into their economies.
In several Asian, including certain BRIC (Brazil, Russia, India and China) economies, output
already exceeds pre-crisis levels by a wide margin and actual output growth in some is
Monetary Policy Review May 2010
South African Reserve Bank
already outpacing potential output growth estimates. The IMF expects China’s economy, for
example, to expand by about 10 per cent in 2010 and 2011. There are concerns that China
might curb credit more comprehensively in an effort to restrain its inflation, which now looks
set to be 3,1 per cent in 2010, up from a previous estimate of 0,6 per cent. China’s growth
momentum might slow in the coming quarters as the central bank implements monetary
tightening. The government also announced that it would nullify all local government loan
guarantees that have supported a substantial part of the investment projects undertaken. In
India growth is projected to be 8,8 per cent in 2010 and 8,4 per cent in 2011, supported
by rising private demand. Consumption in India is expected to strengthen, while investment
is expected to be boosted by strong profitability. The upward revisions to the IMF’s 2010
growth projections in BRIC countries is underscored by the significant improvement in the
leading indicators in these countries during the course of 2009 (Figure 18).
Although the financial turbulence struck Africa through many different channels, all across
the continent there have subsequently been significant rebounds in trade, export earnings,
bank credit and commercial activity. The IMF expects growth in sub-Saharan Africa of
4,7 per cent in 2010, but cautions that this is incumbent upon the global recovery. Those
African countries that had undertaken good policies in years prior to the financial crisis were
less affected by the downturn in economic activity. This was the result of strengthened fiscal
positions, lower inflation and comfortable reserve cushions. Those countries with improved
debt positions were able to use their budgets to dampen the impact of the crisis, including
preserving social spending. However, Africa remains very vulnerable to commodity price
volatility, instability in neighbouring countries, significant reliance on remittances, aid and
financial flows and the ever-present possibility of natural disasters.
The composite leading indicator compiled by the OECD projects strong signs of
economic expansion in the OECD area after increasing by 12,8 per cent in March 2010,
compared with the corresponding month of the previous year (Figure 19). The JPMorgan
global manufacturing Purchasing Managers’ Index (PMI) remains high by historical
standards, continuing its upward trend in April 2010 when it increased by 1 point to 57,8
(the highest level since May 2004). The global manufacturing PMI has been indicating
sustained expansion in recent months. The year-on-year rate of change in the OECD
industrial production index accelerated to 7,8 per cent in February 2010, following a
protracted contraction from July 2008 to December 2009. Real output growth in the
South African Reserve Bank

Monetary Policy Review May 2010
Long-term trend = 100

Brazil

Russia
Source: OECD
Figure 18 Composite leading indicators

China

South Africa

India

OECD area accelerated from 2,4 per cent in the third quarter of 2009 to 3,2 per cent in
the fourth quarter. The improved performance in the OECD area was mainly due to rapid
growth in the US and Japan. By contrast, GDP growth in the euro area slowed in the fourth
quarter of 2009. The UK also recorded positive GDP growth in the fourth quarter after six
consecutive quarters of contraction.
The euro-zone manufacturing PMI rose to 57,6 in April 2010 from 56,6 in March. A
weakened euro and rising global demand helped boost export growth to the highest
level in 10 years in April 2010. Leading indicators of manufacturing activity in the euro
zone have improved significantly in recent months, linked to robust manufacturing
activity around the globe, as the sector recovers following an extraordinarily deep
collapse during the financial crisis. Germany, Europe’s largest economy, benefited from
rising global demand, which pushed the country’s PMI reading to 61,5 in April 2010 from
60,2 in March, the highest level since the series commenced in April 1996. The
manufacturing PMI reading for France, the euro-zone’s second-largest economy, also
rose to 56,6 from 56,5 in March, boosted by a sharp rise in new order volumes. Italy’s
data also showed accelerated activity, with the PMI rising to 54,3 from 53,7 in March.
Data showed that activity in Spain expanded at its strongest rate in 3 years, but
continues to lag that of other big economies in the region. The nation’s manufacturing
PMI reached 53,3 in April from 51,8 in March. National divergences in April marked a
survey record, ranging from record output growth in Germany to a steep and
accelerating rate of contraction in Greece, where output is falling at a rate not far off the
one seen at the very height of the financial crisis.
The global economic recovery that commenced in 2009 was based on an average
crude oil price of US$67 per barrel from the second to the fourth quarter of the year, and
there is mounting concern that higher oil prices could hinder the recovery. Although the
oil price has risen significantly in recent weeks, the medium-term outlook is for upward
price pressure to remain moderate for some time and that recent price pressure has
been mainly the result of speculative transactions based on the improving global
outlook. OPEC spare capacity and OECD inventories are still well above recent historical
averages and, although the oil futures curve has not yet returned to the usual state of
backwardation, the spread between futures and spot prices has narrowed significantly.
Monetary Policy Review May 2010
South African Reserve Bank
Percentage change over 12 months
Index points

OECD composite leading indicator

OECD industrial production index

JPMorgan global manufacturing PMI (right-hand scale)
Sources: OECD and JPMorgan
Figure 19 Selected indicators of global economic activity


Futures markets foresee modest oil price increases in the medium term, with prices
rising to just above US$83 at the end of 2010.
Inflation expectations have generally remained well anchored worldwide despite
extraordinarily accommodative monetary and fiscal policies, and this, together with stilllow levels of capacity utilisation, should serve to keep inflation in check in most
countries. However, further falls in inflation were slowed or inhibited by nominal
downward rigidities becoming more binding at very low inflation rates in a number of
advanced economies. In some countries, unit costs rose due to a reluctance to lay off
existing employees despite the slowdown in economic activity. In the face of weak
revenues and deteriorating financial conditions, some countries’ firms resisted lowering
prices and margins in order to rebuild working capital. The decline in inflation pressure
at the global level has been limited by the strong cyclical position of key emerging
economies. This has provided a strong boost to commodity prices and is an important
reason why both excess capacity in commodity production and excess inventories in a
number of commodities markets are lower than is usual for this stage of the global cycle.
Inflation in many emerging economies has continued to be higher than in the advanced
economies and quite variable from year to year. Inflation slowed but remained quite high
throughout the cycle in various Latin American, Middle Eastern and Commonwealth of
Independent States economies. In India inflation rose strongly due significantly to onetime factors, while in Russia it fell appreciably. Inflation fell moderately in Brazil, while in
China prices actually declined for a while, but are now rebounding quickly.
Outlook for domestic demand and supply
After three consecutive quarters of improvement, GDP growth is expected to sustain its
stronger performance in 2010 and 2011. According to the Bank’s latest quarterly
projections, real output is expected to grow at annual average rates of 2,7 and 3,6 per
cent in 2010 and 2011 respectively (Figure 20). Quarter-on-quarter annualised real GDP
growth is expected to be 3,7 per cent in the first quarter of 2010 and 3,2 per cent in the
second quarter.
South African Reserve Bank

Monetary Policy Review May 2010
Percentage change at seasonally adjusted annualised rates

Figure 20 Real GDP growth forecast


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

According to the March 2010 Reuters survey of long-term forecasts for the South African
economy, analysts expect real GDP to grow by 2,88 and 3,52 per cent in 2010 and 2011
respectively, and reach 3,86 per cent in 2012. By comparison, the National Treasury’s
February 2010 Budget Review expected real output growth to register 2,3 and 3,2 per
cent in 2010 and 2011, and reach 3,6 per cent in 2012. On the demand side, sources of
growth during this forecast period are expected to be final consumption by households
and government, gross fixed capital formation and net exports. On the supply side, the
secondary and services sectors are expected to be the main sources of growth.
The continuing momentum in economic growth is supported by the seasonally adjusted
Kagiso PMI, which measures domestic manufacturing activity. Figure 21 shows that this
indicator rose from 50,3 index points in November 2009 to 55,2 index points in
April 2010. The April PMI employment index posted an above-50 reading of 56,3 index
points, while the expected business conditions index registered 65,7 index points.
These trends point to the manufacturing sector’s positive contribution to output growth
in the first quarter of 2010.
The Bank’s composite leading indicator has increased by close to 19 per cent in the
12-month period ending February 2010 (Figure 22). The increase in the leading indicator
was evenly spread, with five of the eleven component time series assessed increasing
and six decreasing.
As far as the quarterly analysis of manufacturing activity is concerned, the first quarter
2010 BER survey revealed that manufacturing business confidence increased from
19 index points in the fourth quarter of 2009 to reach 28 in the first quarter of 2010.
According to Statistics South Africa data, manufacturing production for March 2010
rose by 6,3 per cent compared with March 2009.
The FNB Building Confidence Index, which measures the business confidence of all the
major role-players and suppliers involved in the building industry, rose marginally from an
index value of 28 in the fourth quarter of 2009 to 30 in the first quarter of 2010. Four out
Monetary Policy Review May 2010
South African Reserve Bank
Index points

Employment

Expected business conditions

Kagiso PMI
Source: Kagiso Securities and Bureau for Economic Research, Stellenbosch University
Figure 21 Kagiso PMI

of six subcomponents of the index registered increases. Improvements in confidence
levels were recorded among building contractors (+2), subcontractors (+7), architects
(+16) and retailers of building materials (+2). Declines occurred in the case of
manufacturers of building materials and quantity surveyors. As far as short-term
prospects for the residential sector are concerned, survey respondents expect business
conditions to improve in the second quarter of 2010.
Although it is currently below the net-positive level of 50, the RMB/BER Business
Confidence Index rose sharply from 28 index points in the fourth quarter of 2009 to
reach a level of 43 during the first quarter of 2010 (Figure 23); this is the single biggest
increase between two consecutive quarters in 16 years. New vehicle dealer confidence
rose sharply from an index level of 29 in the fourth quarter of 2009 to 60 in the first
quarter of 2010. The surge in confidence was due to sales that surpassed expectations.
Wholesaler confidence increased from 27 to 50.
South African Reserve Bank

Monetary Policy Review May 2010
Index: 2000 = 100

Figure 22 Composite leading business cycle indicator

Index
1980 82

98 2000 02

Sources: Rand Merchant Bank and Bureau for Economic Research, Stellenbosch University
Figure 23 RMB/BER Business Confidence Index
Net positive
Net negative

During the first quarter of 2010 the FNB/BER Consumer Confidence Index increased by
9 index points to reach +15, the highest reading since the fourth quarter of 2007.
Consumers rating the present period as an appropriate time to buy durable goods
increased on a net basis by 11 index points to -4. In addition, the net percentage of
consumers expecting an improvement in South Africa’s economic performance during
the next 12 months rose from +16 in the fourth quarter of 2009 to +23 index points in
the first quarter of 2010.
Indicators of inflation expectations
Estimates of inflation expectations for the forecast period from 2010 to 2012 obtained
from the BER survey conducted during the first quarter of 2010 show that average
annual CPI inflation is expected to decline over the forecast years, although it is
expected to remain above the inflation target range of 3 to 6 per cent. Inflation
expectations in the first quarter of 2010 are lower at all time horizons than those
surveyed in the preceding quarter. As depicted in Figure 24, average CPI inflation
expectations for 2010 are 6,5 per cent, followed by 6,7 per cent for 2011 and 6,8 per
cent for 2012. The inflation expectations of business and trade unions were above the
inflation target range, while those of financial analysts were either at the upper level of,
or within, the range.
The April 2010 Reuters survey of long-term forecasts for the South African economy,
which surveys a group of financial market analysts, reports that targeted CPI inflation is
expected to be consistent with the official target range of 3 to 6 per cent from 2010 until
the end of the forecast period in 2012 (Table 11). It is expected that CPI inflation will
average 5,3 per cent in 2010 and 5,8 per cent in 2011, and be at the upper level of the
inflation target range at 6,0 per cent in 2012.
Monetary Policy Review May 2010
South African Reserve Bank
Annual averages, per cent

1st qr 2010

Figure 24 BER surveys of headline CPI inflation expectations

Survey conducted during:

3rd qr 2009
Source: Bureau for Economic Research, Stellenbosch University

4th qr 2009
Table 11
Reuters survey of CPI inflation forecasts: April 2010*
Per cent


(23)

(17)

*
March 2010 survey results in parentheses
Source: Reuters
Inflation expectations as proxied by break-even inflation rates, measured as the
difference between the yields on South African CPI inflation-linked bonds and
conventional nominal bonds of similar maturity, trended lower from the beginning of the
year until the end of April 2010 (Figure 25). From the beginning of May break-even
inflation rates began rising due to increases in nominal bond yields which were likely
triggered by risk premia associated with developments in sovereign bonds in Europe.
The break-even rate for the 3–4 year maturity range was 6,0 per cent on 11 May 2010,
while that for the 13–15 year maturity range was 5,8 per cent.
The South African Reserve Bank inflation forecast
The most recent projections of the Bank’s quarterly inflation forecasting model,
presented to the MPC meeting on 11–13 May 2010, are reproduced in the form of a fan
chart in Figure 26. According to these projections, the targeted inflation rate is expected
to remain within the inflation target range of 3 to 6 per cent until the end of 2012. The
projections for 2010 and 2011 are slightly below those presented in the previous
Monetary Policy Review in November 2009.
South African Reserve Bank

Monetary Policy Review May 2010
Percentage points

Figure 25 Break-even inflation rates

Spread between R189 and R206 bonds (3- to 4-year maturity)

Spread between R197 and R186 bonds (13- to 15-year maturity)

The central projection, conditional on an unchanged repurchase rate, is for the average
quarterly CPI inflation rate to decelerate further to 4,7 per cent in the third quarter of
2010. It will then fluctuate between 4,9 and 5,6 per cent until the end of the forecast
period in the final quarter of 2012, when it will be 5,3 per cent. This forecast includes an
increase of 20 per cent in the electricity price to accommodate the increase approved
by the National Electricity Regulator of South Africa (NERSA). The main risks to the
inflation outlook are from the risks emanating from the global economy and from
administered price developments. Outcomes for the exchange rate of the rand,
commodity prices or electricity prices that differ from those assumed in the model will
impact on the central projection.
Assessment and conclusion
During the second half of 2009, the world economy emerged from the global recession.
In the course of the year, the pace of recovery accelerated and by the beginning of 2010
most global growth forecasts were being revised upwards. In some countries the
authorities were beginning to reverse some of the extraordinary measures that were put
in place during the crisis. Nevertheless, there were still some concerns that an
excessively rapid reversal of these policies, and normalisation of fiscal and monetary
policy stances would delay or even reverse the recovery. It was also becoming evident
that the pace of recovery was very uneven across economies and regions. The recovery
was being led by the emerging markets, particularly those in Asia, while the outlook for
the euro area was far less favourable. During this period, there were increasing concerns
about the solvency of a number of countries in the euro area, as fiscal deficits widened
and debt rose considerably. There was an increased danger that the initial banking crisis
could transform into a sovereign debt crisis, which could also have systemic implications
Monetary Policy Review May 2010
South African Reserve Bank
Per cent

Figure 26 Targeted inflation* forecast

* CPIX for metropolitan and other urban areas until the end of 2008; CPI for all urban
areas thereafter
Note:
The fan chart uses confidence bands to depict varying degrees of
certainty. The darkest band of the fan chart covers the most likely 10 per
cent of probable outcomes foreseen for inflation, including the central
projection. Each successive band, shaded slightly lighter and added on
either side of the central band, adds a further 10 per cent to the probability,
until the whole shaded area depicts a 90 per cent confidence interval (see
Box 4 “Understanding the fan chart” on p. 27 of the March 2001 Monetary
Policy Review).
for the global economy. The global financial markets became increasingly nervous and
volatile, until decisive action was taken by European governments, the ECB and the IMF
in early May 2010. While the immediate threat to global growth and stability appears to
have dissipated somewhat, risks remain that the required fiscal adjustment in these
countries may not be possible.
The South African economy has also emerged from the recession, although the recovery
has not only lagged that of some of the emerging-market economies, but the rate of
growth has also been slower. This has been partly due to the continued slow revival of
domestic household consumption expenditure and a continued contraction in privatesector fixed capital formation. The manufacturing sector, however, appears to have
recovered somewhat in the past few months. Despite the more favourable growth
outlook, the output gap is expected to remain positive for some time. The growth
performance will also be affected by the performance of the global economy and the
risks posed by developments in the euro area.
Despite an upward trend in some international commodity prices over the past months,
the global inflation environment remains benign and is not a threat to the domestic
inflation outlook. Inflation has returned to within the inflation target range and it is
expected to remain within the range during the forecast period. The positive outlook
allowed for an additional 50 basis point reduction in the repurchase rate in March 2010.
At that time the favourable inflation trajectory and lower perceived risks to the inflation
forecast gave space for an additional monetary policy stimulus to reinforce the
sustainability of the domestic growth upswing, without jeopardising the achievement of
the inflation target. More recently, as the risks to the outlook became more evenly
balanced, the MPC assessed the current monetary policy stance to be appropriate for
the achievement of the inflation target and a sustainable growth recovery.
South African Reserve Bank

Monetary Policy Review May 2010

Statement of the Monetary Policy Committee
26 January 2010
Issued by Gill Marcus, Governor of the South African Reserve Bank, at a meeting of the
Monetary Policy Committee (MPC) in Pretoria
Introduction
The longer-term inflation outlook remains relatively favourable, notwithstanding some
base effects that are likely adversely to affect the inflation outcomes in the short term.
Domestic consumption expenditure remains under stress and there are no perceived
risks to the inflation outlook from this source. Despite the continued contraction of
private-sector gross fixed capital formation, the domestic economic growth outlook
appears to have improved, but is expected to remain below the potential output growth
for some time. The global economy is characterised by an uneven recovery across
regions and some risks persist, while the global inflation outlook appears to be contained.
Recent developments in inflation
The year-on-year inflation rate as measured by the consumer price index for all urban
areas (CPI) declined from 6,1 per cent in September 2009 to 5,9 per cent and 5,8 per
cent in October and November respectively. The categories of housing and utilities, and
miscellaneous goods and services remained the single biggest contributors to the
inflation outcome in November, having contributed 1,7 and 1,5 percentage points
respectively. These categories were mainly driven by electricity and insurance cost
increases. Food price inflation continued to moderate and measured 4,0 per cent in
November, while administered prices excluding petrol and paraffin increased by 11,0 per
cent, primarily as a result of electricity price increases.
Producer prices declined at year-on-year rates of 3,3 per cent and 1,2 per cent in
October and November respectively. The underlying producer price trends in the food
sector remained favourable for further moderation in food price inflation at the consumer
level. In November agricultural prices increased at a year-on-year rate of 0,9 per cent,
while manufactured food prices declined by 1,1 per cent.
The outlook for inflation
CPI inflation is expected to increase to above the target range in the coming three
months, due to technical base effects related to petrol price changes. Current forecasts
indicate that inflation could measure around 6,5 per cent in December and January,
before moderating in the subsequent months. Because of the forward-looking nature of
monetary policy, the focus of the Monetary Policy Committee (MPC) is on the longer-term
expected trend of inflation. The CPI inflation forecast by the South African Reserve Bank
(the Bank) is predominantly unchanged since the November forecast. In line with market
forecasts, inflation is expected to return to within the inflation target range on a sustained
basis in March 2010, and remain within the target range until the end of the forecast
period in the final quarter of 2011, when it is forecast to average 5,4 per cent.
Since the previous MPC meeting, Eskom has modified its tariff application to the National
Energy Regulator of South Africa (NERSA). Given the continued uncertainty related to the
electricity tariff increases, the forecast does not make provision for the full multi-year
increases of 35 per cent requested by Eskom, and electricity price increases of 25 per
cent in 2010 and 2011 are assumed. The outcome of the Eskom application is expected
to be announced in February.
Monetary Policy Review May 2010
South African Reserve Bank
The most recent inflation expectations survey conducted by the Bureau for Economic
Research (BER) at Stellenbosch University shows that in the fourth quarter of 2009 there
were no significant changes in expectations compared with the previous survey.
According to the survey, inflation is expected to average 7,5 per cent in 2010 and 7,7 per
cent in 2011. While both business and trade union respondents continued to expect
inflation to remain outside the target range, the forecasts of financial analysts deteriorated
moderately but remained within the target range. The latter forecasts were in line with the
Reuters survey, which in January showed that market analysts expect inflation to average
5,7 per cent and 5,8 per cent in 2010 and 2011 respectively.
The demand-side pressures on inflation have been persistently weak, and the MPC
remains of the view that there are no significant upside risks to the inflation outlook
emanating from this source.
Real final consumption expenditure by households has contracted on a quarter-onquarter annualised basis since the third quarter of 2008. In the third quarter of 2009
household consumption expenditure declined by 2,0 per cent. This weak trend appears
to have continued in the final quarter of 2009. Real retail trade sales declined at a yearon-year rate of 6,6 per cent in November 2009 and by 5,9 per cent in the three months
to the end of November compared with the same period in 2008. Wholesale trade sales
also declined in November. New vehicle sales continue to show some signs of
improvement, but nevertheless contracted by 7,2 per cent in December on a year-onyear basis. Consumer confidence appears to have improved, however, as reflected in the
First National Bank (FNB)/BER Consumer Confidence Index which recorded its highest
reading since the first quarter of 2008.
Adverse employment trends and employment insecurity are likely to constrain household
consumption expenditure. According to Statistics South Africa’s Quarterly Employment
Statistics, employment levels decreased further during the third quarter of 2009, despite
a more favourable growth performance. Formal non-agricultural employment declined by
4,2 per cent in this quarter, representing almost 110 000 jobs. Employment is expected
to lag the growth recovery.
Credit extension to the private sector reflects the weak demand and tight credit supply
conditions, and is also seen as a constraint on spending. There are, however, indications
that the strict lending criteria applied by banks in response to higher perceived risk and
rising impaired advances may be easing. In November 2009 impaired advances as a
percentage of total gross loans and advances increased to 5,9 per cent from 5,8 per cent
the previous month. Total loans and advances to the private sector contracted by 2,0 per
cent in November compared with the previous year. This was the third consecutive month
of credit contraction. The only component of credit extension that recorded positive
nominal growth was mortgage advances, which grew at a 12-month rate of 3,0 per cent.
These developments were also reflected in the level of household debt, where the ratio of
household debt to disposable income declined from 80,1 per cent in the second quarter
of 2009 to 79 per cent in the third quarter. This relatively high level of debt is expected to
continue to constrain consumption expenditure.
While the combination of increased unemployment, the lack of access to credit and the
need to repair impaired household balance sheets is expected to dominate consumption
trends in the coming quarters, there have been some positive developments with respect
to wealth effects. House prices have shown signs of improvements, with the Absa and
FNB house price indices showing positive but moderate growth. Equity prices have
recovered somewhat since their lows in March of 2009, but the recent equity market
decline both domestically and abroad shows that some volatility may persist in line with
uncertainty relating to the sustainability of the global recovery.
South African Reserve Bank

Monetary Policy Review May 2010

There are continued signs that the domestic economic recovery is under way following
the 0,9 per cent annualised gross domestic product (GDP) growth rate measured in the
third quarter of 2009. However, the recovery is expected to remain relatively subdued and
below the potential growth rate of the economy for some time. The forecast of the Bank
is that GDP growth will average 2,0 per cent in 2010 and 3,0 per cent in 2011.
Nonetheless, it could take some time until pre-recession levels of output are reached. The
more positive outlook is in line with the continued positive trends seen in the composite
leading business cycle indicator of the Bank, which increased strongly again in
November. The coincident indicator also exhibited a slight upward movement. These
trends are in line with the more positive outlook seen in the Rand Merchant Bank
(RMB)/BER business confidence index during the fourth quarter of 2009.
The manufacturing sector has also shown signs of some recovery and is expected to
contribute positively to the 2009 fourth quarter growth outcome. The physical volume of
manufacturing production declined at a year-on-year rate of 4,7 per cent in November,
but increased by 3,9 per cent in the three months to November compared to the previous
three months. The Kagiso Purchasing Managers Index (PMI) also reflected a positive
outlook in November and December. However, the manufacturing sector may be
constrained by weak domestic demand, while external demand will be impacted by the
strength of the global recovery as well as, in part, by exchange rate developments.
The rand has remained a positive factor from an inflation perspective. However, the MPC
is cognisant of the negative impact of the rand’s movements during the past year on
some sectors of the economy. Since the previous MPC meeting, the rand/dollar
exchange rate has fluctuated between around R7,28 and R7,73. On a trade-weighted
basis, the rand has remained more or less unchanged since the previous meeting. Much
of the volatility of the exchange rate during this period can be explained by general
volatility in the international foreign exchange markets where the US dollar fluctuated in a
range of US$1,41 and US$1,51 against the euro.
With the decline of risk aversion in global markets, emerging markets in general, including
South Africa, have also had to deal with significant capital inflows. These inflows have put
upward pressure on a number of emerging market currencies. Intervention to prevent
these appreciations is often costly and not always effective. At the same time, the
possibility of reversals of these flows, should global sentiment change, poses a risk to the
exchange rate outlook in these countries.
The global recovery has continued with relatively strong performances in some of the
emerging-market economies. However, risks and vulnerabilities still remain, particularly in
a number of countries in the euro area, and the recovery is expected to remain relatively
slow in some economies that are important export destinations for South African goods.
Unsustainable fiscal positions, as well as the need to reverse previous unconventional
monetary policy interventions, may also pose a risk to the global growth outlook. The
global environment remains benign from an inflation perspective. Despite moderately
higher commodity prices, there are no significant risks to the global inflation outlook.
Other supply-side or exogenous factors are not expected to impart a significant upside
risk to the inflation forecast. International oil prices appear to have stabilised somewhat
over the past months and moderate increases have been assumed over the forecast
period. The outlook for food price inflation, as reflected in producer prices and futures
prices, is favourable and these prices are unlikely to pose an upside risk to the inflation
outlook for some time despite higher food prices in international markets.
The risk to the inflation outlook emanating from wage developments appears to have
subsided somewhat. Wage settlements are still in excess of inflation, but have been
Monetary Policy Review May 2010
South African Reserve Bank
declining in nominal terms. Average nominal remuneration per worker in the formal nonagricultural sector moderated to 7,6 per cent in the third quarter of 2009, while the
nominal unit labour cost increase in the third quarter compared with the same quarter the
previous year measured 5,7 per cent.
Electricity price increases remain the single biggest risk to the inflation outlook. There is
the risk that increases granted to Eskom could be markedly higher than those assumed
in the Bank’s forecast, and there is also the risk that the second-round effects of these
increases may be underestimated by the forecasting model.
Monetary policy stance
The MPC noted that inflation is likely to remain close to the upper end of the target
range over the forecast period and is of the view that the risks to this outlook are fairly
evenly balanced. Electricity price increases pose the biggest upside risk, counteracted
by the weak state of domestic demand. Against this background the MPC has decided
to keep the repurchase rate unchanged at 7,0 per cent per annum.
South African Reserve Bank

Monetary Policy Review May 2010

Statement of the Monetary Policy Committee
25 March 2010
Issued by Gill Marcus, Governor of the South African Reserve Bank, at a meeting of the
Monetary Policy Committee (MPC) in Pretoria
Introduction
The domestic economy has shown signs of moderate improvement since the previous
meeting of the MPC. Inflation expectations have moderated. Inflation has returned to
within the target range and is expected to remain there for the remainder of the forecast
period. The risks to the inflation outlook have declined somewhat as a result of the
continued appreciation of the exchange rate of the rand and greater certainty with
respect to future electricity tariff increases. Household consumption expenditure is
growing at positive, albeit low rates, but growth in private sector fixed capital formation
remains negative.
Recent developments in inflation
The year-on-year inflation rate as measured by the consumer price index for all urban
areas (CPI) returned to within the inflation target range sooner than expected, in
February 2010, when it measured 5,7 per cent. The moderation in inflation was fairly
broad-based. The main contributors to the inflation outcome were the categories of
housing and utilities, and miscellaneous goods and services. The former category was
driven mainly by electricity price increases of 26,8 per cent, while the latter category was
driven by insurance costs relating to housing, health and transport. Food price inflation
declined to 1,0 per cent, while communication costs declined by 22,0 per cent.
Administered prices excluding petrol and paraffin increased by 10,8 per cent.
Producer price inflation increased to 3,5 per cent in February 2010, compared with
2,7 per cent in the previous month. Food price inflation at the producer level remained
well contained. Agricultural food prices declined at a year-on-year rate of 13,5 per cent,
while manufactured food prices declined by 1,2 per cent.
The outlook for inflation
The CPI forecast of the South African Reserve Bank (the Bank) indicates an improved
inflation outlook during 2010 and a relatively unchanged outlook for 2011. Inflation is
expected to average 5,3 per cent and 5,4 per cent in 2010 and 2011 respectively, and
to reach a low point at an average of 4,9 per cent during the third quarter of 2010. There
is now greater certainty with respect to electricity tariff increases following the decision
by the National Energy Regulator of South Africa (NERSA) to grant price increases to
Eskom in the order of 25 per cent per annum, which was in line with the Bank’s previous
assumptions. However, because lower increases were granted to municipalities, the
current forecast makes provision for electricity tariff increases of 20 per cent during the
third quarters of 2010 and 2011. Other factors contributing to the improved expected
inflation trajectory include favourable food price developments and lower-than-expected
inflation outcomes.
The Survey of Inflation Expectations published by the Bureau for Economic Research
(BER) at Stellenbosch University shows a significant improvement in the first quarter of
2010, although expectations on average remain above the upper end of the target
Monetary Policy Review May 2010
South African Reserve Bank
range. Average headline CPI inflation expectations in respect of 2010 declined from
7,7 per cent during the final quarter of 2009 to 6,5 per cent during the first quarter of
2010. Inflation expectations in respect of 2011 declined from 7,7 per cent to 6,7 per
cent, and the expectation for 2012 is 6,8 per cent. The improved outlook was mainly
due to the favourable change in the expectations of business sector and labour union
respondents. The expectations of analysts remained more or less unchanged.
Inflation expectations in the financial markets also reflected a more favourable inflation
outlook. The Reuters survey of financial analysts shows some improvement relative to
the previous month. Inflation expectations as measured by the yield differential
between conventional government bonds and inflation-linked bonds across all
maturities have declined since January, and reflect expectations within the target
range over longer maturities.
Growth in domestic expenditure appears to be recovering at a modest pace but does
not currently pose an upside risk to the inflation outlook. Following five consecutive
quarters of negative growth, real household consumption expenditure increased at an
annualised rate of 1,4 per cent in the fourth quarter of 2009. While expenditure growth
on non-durable and semi-durable goods contracted, expenditure on durable goods,
particularly motor vehicles, increased. Wholesale and retail trade sales in January appear
to confirm this trend as positive month-on-month growth was experienced. Consumer
confidence, as reflected in the First National Bank/BER Consumer Confidence Index,
showed a significant recovery.
The turnaround in household consumption expenditure is expected to continue at a slow
pace. The improvements in the domestic equity markets appear to have reversed the
negative wealth effects on consumption. Nevertheless, the recovery in household
consumption expenditure is expected to be constrained by the levels of household
indebtedness, which increased to 79,8 per cent of disposable income of households in
the fourth quarter of 2009. Other constraining factors include the strict credit criteria
applied by banks and persistently high levels of unemployment.
Growth in total loans and advances to the private sector has been negative since
September 2009 and declined further at a 12-month rate of 1,2 per cent in January.
Mortgage credit extension was again the only category that showed positive growth,
while loans to companies declined further. The subdued credit extension data are a
function of both demand and supply-side effects. The strict credit criteria applied by
banks have been partly a result of the rising levels of impaired advances, which now
appear to be levelling off. In January 2010 impaired advances as a percentage of total
gross loans and advances declined slightly to 5,9 per cent. A significant proportion of
these impairments relate to retail loans, reflecting continued pressure on the consumer.
There are indications that the decline in employment in the formal non-agricultural sector
appears to have slowed. According to the Quarterly Employment Survey, 18 000 jobs
were created in the final quarter of 2009. However, on a seasonally adjusted basis,
employment declined by 0,7 per cent, following the 5,1 per cent decline in the previous
quarter. Cyclical employment trends tend to lag the upturn in the economy and the
impact of the recession on employment will take some time to be reversed.
A countercyclical fiscal policy stance has been maintained. The national government
deficit is projected to equal 7,2 per cent of gross domestic product (GDP) in the 2009/10
fiscal year, then to narrow over the next three years as the economy recovers and to
measure 4,7 per cent in the 2012/13 fiscal year. The public sector borrowing
requirement is expected to reach 11,8 per cent of GDP, and the overall government
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Monetary Policy Review May 2010

debt-to-GDP ratio is expected to peak at 43 per cent in the medium term. Should this
fiscal trajectory be maintained, the MPC does not foresee a possible conflict with
monetary policy objectives.
The economic growth outlook has improved somewhat over the past few months,
although the output gap is expected to remain positive for some time. The 3,2 per cent
annualised growth rate recorded in the fourth quarter of 2009 confirmed that the
economy has emerged from the recession and the latest forecast of the Bank is that
growth is likely to average 2,6 per cent in the current year. Although this compares
favourably with the growth experienced in 2009, it is nevertheless still low.
The manufacturing sector in particular grew relatively strongly in the last two quarters of
2009, although off a low base, following four consecutive quarters of negative growth.
The Kagiso/BER Purchasing Managers Index indicates that this trend is likely to
continue. Business confidence, as measured by the Rand Merchant Bank/BER
Business Confidence Index also showed an improvement, but remains negative.
The sustainability of the recovery in domestic growth will be influenced to a significant
degree by the global growth trends. The pattern of the global economic recovery has
remained unchanged, with strong growth being recorded in Asia in particular, and more
moderate growth in a number of countries in Latin America and Africa. The outlook for
the United States (US) and Europe is less positive, with increased concerns about the
sustainability of burgeoning fiscal deficits and government debt ratios. In the US the
weak housing market also remains a constraint on household consumption expenditure.
Although a number of countries have begun to normalise their policy rates, monetary
and fiscal stimuli still remain in place in most industrialised economies, and indications
are that there will not be an early reversal of these accommodative policies. Against this
backdrop, the benign global inflation environment is expected to persist and the risk of
imported inflation is relatively low.
While an appreciated rand exchange rate is a positive factor in the inflation outlook, an
excessively strong exchange rate is a cause for concern from the perspective of overall
macroeconomic balance. It is difficult to determine with precision an appropriate level of
the exchange rate, but at recent levels the exchange rate may contribute to constraints
in the recovery of export- and import-competing sectors of the economy.
Since the previous meeting of the MPC, the rand has appreciated from levels of around
R7,60 against the US dollar to current levels of around R7,35. On a trade-weighted
basis, the rand has appreciated by about 6 per cent since the previous meeting and by
3 per cent since the beginning of the year. The trade-weighted exchange rate was also
influenced by the recent weakness in the euro and pound sterling against the US dollar.
Since the previous meeting, the rand has appreciated by about 8 per cent and 11 per
cent against the euro and pound sterling respectively.
A number of factors continue to impact on the exchange rate of the rand. These include
the sustained capital inflows into emerging markets, in general, in response to
abnormally low interest rates in advanced economies, investor sentiment and the
recovery in commodity prices. The recovery in commodity prices contributed to the
narrowing of the deficit on the current account of the balance of payments in the final
quarter of 2009 to 2,8 per cent of GDP.
Other supply-side or exogenous factors are not expected to impart a significant upside
risk to the inflation forecast. International oil prices have remained relatively stable in the
Monetary Policy Review May 2010
South African Reserve Bank
US$70 to US$80 dollar range, and moderate increases over the forecast period have
been incorporated into the inflation forecast. Nevertheless, an increase in the order of
50 cents per litre has been assumed for April; about half of which is due to increased
fuel levies announced in the budget.
Domestic food prices, which for most of last year were one of the main sources of
upside risk to the inflation outlook, have recently contributed favourably to the inflation
outlook. In the past few weeks maize prices have declined significantly, despite an
upward trend in other food prices globally. While it is not clear at this stage to what
extent these price declines will be passed on to the consumer, these developments
should at least constrain food price increases for some time.
Wage settlements continue to indicate some moderation, but remain positive in real
terms. The ratio of total compensation of employees to real GDP declined from 10,1 per
cent in the year to the third quarter of 2009 to 9,2 per cent in the year to the fourth
quarter. Nominal unit labour costs increased from 5,7 per cent in the third quarter to
8,8 per cent in the fourth quarter of 2009, but this figure was distorted by significant oneoff adjustments to some public-sector pay scales.
Despite the reduced uncertainty associated with the electricity tariff increases, electricity
and other administered price increases remain a threat to the inflation outlook. Of
concern is the apparent trend towards greater reliance on high tariff increases to finance
long-term infrastructural expenditure projects. These increases are, in effect, relative
price changes or implicit tax increases. However, they contribute to the general inflation
environment and remain a challenge for monetary policy.
Monetary policy stance
The assessment of the MPC is that despite clear signs that the economy has emerged
from the recession, the pace of recovery is expected to remain slow. The improved
inflation environment has provided some space for an additional monetary stimulus to
reinforce the sustainability of the upswing without jeopardising the achievement of the
inflation target. The MPC has therefore decided to reduce the repurchase rate by
50 basis points to 6,5 per cent per annum with effect from 26 March 2010. The MPC
will continue to assess developments and will adjust the monetary policy stance when
necessary in order to achieve the inflation target.
South African Reserve Bank

Monetary Policy Review May 2010

Statement of the Monetary Policy Committee
13 May 2010
Issued by Gill Marcus, Governor of the South African Reserve Bank, at a meeting of the
Monetary Policy Committee (MPC) in Pretoria
Introduction
Since the previous meeting of the Monetary Policy Committee (MPC), the outlook for
domestic inflation has remained favourable, with inflation still being expected to remain
within the target range over the forecast period. Domestic economic growth prospects
appear to have improved and most growth forecasts have been revised upwards,
despite only a modest recovery in household consumption expenditure.
The risks to this relatively favourable growth outlook have changed somewhat in the past
few days as a result of recent global developments. The uncertainty related to the
sustainability of fiscal deficits in a number of euro area countries, and the reaction of the
financial markets to these events, has renewed fears of possible contagion that could
affect the tentative recovery that has been taking place in most regions, including in
South Africa. The concerted efforts by European governments, the European Central
Bank (ECB) and the International Monetary Fund (IMF) have had some effect on calming
the markets. However, significant risks to the global and domestic recovery remain.
Recent developments in inflation
The year-on-year inflation rate as measured by the consumer price index for all urban
areas (CPI) declined to 5,1 per cent in March 2010 from 5,7 per cent in the previous
month. The category of housing and utilities remained the single biggest driver of
inflation, having contributed 1,6 percentage points, mainly as a result of the impact of a
26,8 per cent year-on-year increase in electricity prices. Food price inflation continued
to contribute favourably to the average inflation outcome, having increased by 0,5 per
cent. Administered prices excluding petrol and paraffin increased by 10,4 per cent,
compared with 10,8 per cent in the previous month.
Producer price inflation increased to 3,7 per cent in March 2010, compared with 3,5 per
cent in February. This upward trend was driven mainly by primary commodity price
increases that do not impact directly on the CPI. Food price inflation at the producer
level remained well contained and should constrain food price inflation at the consumer
price level in the coming months. Agricultural food prices declined at a year-on-year rate
of 6,2 per cent, while manufactured food prices declined by 1,5 per cent.
The outlook for inflation
The CPI forecast of the South African Reserve Bank (the Bank) indicates a slightly
improved outlook compared with that presented at the previous meeting of the MPC,
with a lower projected inflation for 2010 and 2011. CPI inflation is still expected to reach
a low point in the third quarter of 2010 when it is forecast to average 4,7 per cent.
Inflation is then expected to increase moderately and remain within the inflation target
range until the end of the forecast period, which has been extended to the end of 2012,
at 5,3 per cent.
Recent surveys indicate that analysts’ inflation expectations are within the inflation target
range for most of the forecast period. According to the Reuters CPI survey, respondents
Monetary Policy Review May 2010
South African Reserve Bank
expect inflation to average 5,3 per cent in 2010, and 5,8 per cent and 6,0 per cent in
the following two years. Inflation expectations as indicated by inflation-linked bonds also
reflect an improvement since the previous meeting of the MPC and are within the
inflation target range.
According to the WEO published by the IMF in April 2010, global growth is now
expected to average 4,2 per cent in 2010, compared with the October 2009 forecast of
3,1 per cent. However, the recent developments in Europe have raised the possibility of
a renewed crisis that could threaten the global recovery. The reaction of the financial
markets to the downgrading by the rating agencies of some euro area countries was
reminiscent of the aftermath of the collapse of Lehman Brothers in September 2008.
Apprehension about a possible default on Greek sovereign debt sparked concerns of a
contagion effect on other European economies with high fiscal deficits and debt ratios.
There were also fears of a spillover to the European banking sector, which has significant
exposures to the sovereign debt of these countries.
The financial markets initially reacted positively to the concerted and significant policy
interventions announced on 8 May by the euro area governments and the ECB.
However, the markets were subsequently less convinced that the measures taken would
be sufficient to resolve the underlying solvency problem of these countries, or that the
required fiscal consolidations would be politically and socially feasible. These
developments demonstrate the fragility of the global environment and the related
uncertainties pose a downside risk to the global recovery. The global inflation outlook,
however, is expected to remain benign and is not expected to pose an upside risk to
domestic inflation.
For much of the period since the previous MPC meeting, the exchange rate of the rand
had remained relatively stable within a range of around R7,23 and R7,48 against the US
dollar. The turbulence in the global financial markets resulted in a brief but significant
depreciation of the rand against the US dollar, as risk aversion returned to the markets.
Following the announcement of the proposed government interventions in Europe, the
rand appreciated to current rates of around R7,50 against the US dollar.
On a trade-weighted basis, the rand has remained relatively unchanged since the
beginning of the year. Over the same period the rand has depreciated by over 1 per cent
against the US dollar, but has appreciated by around 11 per cent against the euro. At
current levels, the rand remains a positive factor in the inflation outlook, but this is
contingent on developments in the euro area and general risk aversion.
The global developments also highlight the current focus of the financial markets on the
sustainability of fiscal deficits and debt ratios. The South African national government
deficit measured an estimated 6,7 per cent of GDP in the 2009/10 fiscal year, compared
with the projected 7,2 per cent announced in the February budget. The deficit is
expected to narrow over the next three years as the economy recovers and to measure
4,7 per cent in the 2012/13 fiscal year. The overall government debt-to-GDP ratio is
expected to peak at 43 per cent in the medium term. This fiscal trajectory is consistent
with fiscal sustainability and the MPC does not foresee a possible conflict with monetary
policy objectives should this trend be maintained.
The moderate recovery in domestic economic growth appears to be sustained. Both the
composite leading and coincident business cycle indicators of the Bank continued their
upward trend in the first two months of 2010, confirming the positive short-term outlook
for domestic economic activity. The various business confidence indices are also
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Monetary Policy Review May 2010

relatively favourable. The most recent GDP forecast of the Bank is for growth of 2,7 per
cent in 2010 and 3,6 in 2011. At these rates of growth, the output gap is not viewed as
an upside risk to the inflation outlook. The main risks to the growth outlook are seen to
emanate from possible adverse global economic developments.
The growth outlook is underpinned by the continued recovery in the manufacturing
sector, which grew at a broad-based year-on-year rate of 6,3 per cent in March. The
Kagiso/BER Purchasing Managers Index declined in April, but still reflects a continued
expansion of this sector. Total mining production increased at a year-on-year rate of
11,0 per cent in March.
Private-sector demand pressures remain benign from an inflation perspective. There is
some evidence of an improvement in household consumption expenditure. Real retail
sales declined on a year-on-year basis in February, but the shorter-term trends were more
positive. When the three months to February are compared with the previous three
months, an increase of around 3 per cent was recorded. New vehicle sales also
maintained their favourable trends, increasing at a year-on-year rate of 36 per cent in April.
Domestic bank credit extension to the private sector continues to reflect weak demand
conditions despite evidence of some loosening of credit supply constraints. Twelvemonth growth in loans and advances contracted by 0,3 per cent in March 2010. Growth
in mortgage advances declined from 3,9 per cent in February to 3,6 per cent in March,
but nevertheless remained the only category of credit extension to register positive
growth. The most recent Ernst and Young/BER Financial Services Index shows that the
banks have moved to a more neutral position with respect to credit standards applied
to new loans.
Consumption is also determined to some extent by the wealth effects in the economy.
House prices appear to have recovered somewhat, and the various indices now all
reflect positive house price growth. The equity markets have also improved significantly
since their lows in March 2009. However, in the five trading days to 7 May, the JSE AllShare Index declined by almost 10 per cent, demonstrating the vulnerability of the
market to changes in sentiment.
Despite the more favourable growth outlook, employment trends appear to be lagging
the domestic recovery. The Quarterly Labour Force Survey indicates that 171 000 jobs
were lost in the first quarter of 2010. These adverse trends are expected to constrain
household consumption expenditure somewhat and offset, to some extent, the positive
impact on consumption of higher real wage increases.
Notwithstanding these job losses, there is a concern about the possible impact of the
level of wage increases in the economy. According to Andrew Levy Employment
Publications, the average wage settlement rate in the first quarter of 2010 moderated to
8,4 per cent, compared with the 9,3 per cent increase measured in 2009. However, the
MPC noted that a number of wage negotiations are at significantly higher levels, and well
above the current and expected inflation rate. Should a general upward trend in wage
settlement rates transpire, in the absence of compensating increases in productivity, it
could pose an upside risk to the inflation outlook.
Other factors that have a significant impact on the inflation outlook include food and
petrol prices. As noted earlier, food price inflation is expected to remain subdued as a
result of the recent decline in the domestic maize price. The international oil price, having
remained in the range of US$70 to US$80 per barrel for some time, appeared to have
Monetary Policy Review May 2010
South African Reserve Bank
resumed its upward trend since late April. However the recent uncertainty in the financial
markets, which cast doubts about the sustainability of the global recovery, resulted in a
decline in the international price of Brent crude oil to below the US$80 per barrel level.
Monetary policy stance
The assessment of the MPC is that inflation is likely to remain within the inflation target
range over the forecast period, and that the economy is expected to continue on a
recovery path. The risks to the inflation forecast are seen to be more evenly balanced
than at the previous meeting of the MPC. The main risks to the inflation outlook emanate
from administered price developments and from the risks emanating from the global
economy. The domestic growth outlook will continue to be affected by the global
developments. The MPC will continue to monitor these developments closely.
For these reasons, the MPC deems it appropriate to maintain the current stance of
monetary policy. Accordingly, the repurchase rate remains unchanged at 6,5 per cent
per annum.
South African Reserve Bank

Monetary Policy Review May 2010

Abbreviations
Alsi
All-Share Index
BER
Bureau for Economic Research (Stellenbosch University)
BIS
Bank for International Settlements
BOE
Bank of England
BOJ
Bank of Japan
CPI
consumer price index
ECB
European Central Bank
EIU
Economist Intelligence Unit
EU
European Union
FNB
First National Bank
FOMC
Federal Open Market Committee
GDP
gross domestic product
IMF
International Monetary Fund
JSE
JSE Limited
MPC
Monetary Policy Committee
NAB
non-alcoholic beverage
NEER
nominal effective exchange rate of the rand
NERSA
National Energy Regulator of South Africa
OECD
Organisation for Economic Co-operation and Development
OPEC
Organization of the Petroleum Exporting Countries
PMI
Purchasing Managers Index
PPI
producer price index
PPP
purchasing power parity
PSBR
public-sector borrowing requirement
RMB
Rand Merchant Bank
the Bank
South African Reserve Bank
the Fed
Federal Reserve System
UK
United Kingdom
US
United States
WEO
World Economic Outlook
Monetary Policy Review May 2010
South African Reserve Bank