MPC Statement May 24th, 2018


South African Reserve Bank

PRESS STATEMENT
EMBARGO DELIVERY
24 May 2018


STATEMENT OF THE MONETARY POLICY COMMITTEE

Issued by Lesetja Kganyago, Governor of the South African Reserve Bank
In recent weeks, the resurgent US1 dollar and higher US long-bond yields have led
to sharply lower capital flows to the emerging markets. These developments,
coupled with persistently rising international oil prices, have contributed to the
reversal of some of the recent rand strength, tilting the balance of risks to the
domestic inflation outlook to the upside. Nevertheless, inflation is expected to remain
within the inflation target range over the entire forecast period.
The domestic economic growth outlook has improved moderately amid rising
business
and
consumer
confidence,
despite
a
disappointing
first-quarter
performance in a number of key sectors.


1 United States
MPC Statement May 24th, 2018


The year-on-year inflation rate, as measured by the consumer price index for all
urban areas, reached a seven-year low of 3.8% in March 2018 before increasing to
4.5% in April, as the impact of the VAT2 increase and other levies became evident.
Goods price inflation increased from 2.6% to 3.5% while services price inflation
increased from 5.1% to 5.3%. The South African Reserve Bank’s (SARB) measure
of core inflation – which excludes food, fuel and electricity – increased from 4.1% to
4.5%. Year-on-year producer price inflation for final manufactured goods declined
from 4.2% in February to 3.7% in March.
The headline inflation forecast of the SARB is more or less unchanged since the
previous meeting of the Monetary Policy Committee (MPC), despite the upward
adjustments to the international oil price assumption and the weaker starting point for
the trade-weighted exchange rate. The impact of these adjustments on the inflation
forecast was offset in part by a lower food price forecast and a lower starting point.
This follows a succession of downside surprises in core goods and food price
outcomes. The forecasts for 2018 and 2019 are unchanged at 4.9% and
5.2% respectively, while the forecast for 2020 is marginally higher at 5.2% compared
with 5.1% previously. The peak of 5.5% is still expected in the first quarter of 2019
before the impact of the VAT increase largely dissipates.
The forecast for core inflation is marginally lower, at 4.5% for 2018, but has
deteriorated somewhat more than headline inflation in the coming two years, to
5.1% in both years, from 4.9% previously. A peak of 5.2% is expected in the first
quarter of 2019.

2 value-added tax
MPC Statement May 24th, 2018


The implied starting point for the rand in the forecast is R12.37 against the US dollar
compared with R11.97 at the time of the previous MPC meeting. Food prices, by
contrast, are expected to increase by 4.9% in 2018 and by 5.5% in 2019, lower than
in the previous forecast. There is a degree of uncertainty regarding the likely impact
of the VAT increase and the sugar tax on food, and the extent to which these
increases will be absorbed by manufacturers and retailers.
Following persistent increases in international oil prices since February, the
assumptions for Brent crude oil in the SARB’s Quarterly Projection Model were
revised upwards by US$7 per barrel to US$70 for 2018 and by US$5 per barrel, to
US$67, for the next two years. Both the futures markets and the consensus
forecasts indicate some moderation of prices over the next two years.
The inflation expectations of market analysts reflected in the Reuters Econometer
survey have moderated somewhat since March. In the May survey, median inflation
was expected to average 4.9% in 2018, rising to 5.3% in 2020, compared with 5.0%
and 5.5% respectively in the March survey. Expectations implicit in the break-even
inflation rates (i.e. the yield differential between conventional and inflation-linked
government bonds) are more volatile and more sensitive to exchange rate
movements. These expectations show some increase following the recent rand
weakness. While the longer-term expectations are back above 6.0%, the five-year
break-even rate remains within the target range. The next BER3 inflation
expectations survey will be published in July.


3 Bureau for Economic Research
MPC Statement May 24th, 2018


The global economic backdrop has become more challenging amid continuing trade
policy tensions between the US and China as well as other geopolitical risks.
Although the economic growth outlook in the advanced economies generally remains
positive, there are signs that the momentum may be slowing. Global inflation
remains on a moderate upward trend, but still at low levels. However, the rising
international oil prices could derail the relatively benign global inflation prognosis.
Since the previous meeting of the MPC, the rand has depreciated significantly,
against the US dollar in particular, reversing much of the overvaluation seen at that
time. Since then, the rand has depreciated by 6.0% against the US dollar, by 0.7%
against the euro, and by 2.8% on a trade-weighted basis.
The main driver of this recent rand weakness has been developments in the US
financial markets, where Treasury yields exceeded 3.0% for the first time since
July 2011. This was in response to wider fiscal deficits, rising inflation expectations
and expectations of further US monetary policy tightening – a key risk highlighted in
the previous MPC statement. As a consequence, a number of emerging markets
have experienced capital outflows and currency depreciation, with those with wider
current account deficits and other macroeconomic imbalances being most
vulnerable. Month-to-date in May, non-residents have been net sellers of South
African government bonds to the value of R33.6 billion, contributing to the sharp
increase in long-term domestic bond yields.


MPC Statement May 24th, 2018


At this stage, the likelihood of further sustained dollar strengthening is unclear. Apart
from US domestic issues, it is likely to be influenced by geopolitical risks, trade
conflicts, and expectations of changes in monetary policy in other advanced
economies. In the near term, the rand is expected to remain volatile, with
movements dominated by the changing assessment of these global trends.
Domestically, an expected moderate widening of the current account deficit, a result
of deteriorating terms of trade, could also weigh on the rand.
The domestic growth outlook remains challenging, although growth is still expected
to outperform recent year outcomes. This is despite the possibility of a contraction in
GDP4 in the first quarter of this year, following negative growth in both the mining
and the manufacturing sectors. The SARB’s forecast for GDP growth is unchanged
at 1.7% for 2018, but has been revised up from 1.5% to 1.7% for 2019. The forecast
for 2020 is unchanged at 2.0%. The forecast remains consistent with a closing of the
negative output gap by 2020, but at a slightly faster pace than before. The continued
increase in the composite leading business cycle indicator confirms the upward
momentum in the economy.
The growth outlook is underpinned by strong recoveries in both business and
consumer confidence. The RMB5/BER Business Confidence Index, while still below
the neutral level, increased by an unusually large 11 index points from 34 in the
fourth quarter of 2017 to 45 in the first quarter of 2018. This is expected to be
supportive of higher growth in gross fixed capital formation, particularly by the private

4 gross domestic product
5 Rand Merchant Bank
MPC Statement May 24th, 2018


sector. The recent signing by government of the Independent Power Producer
programme has added to the improved outlook.
The FNB6/BER Consumer Confidence Index surged from negative territory to an alltime high in the first quarter, driven mainly by the positive reaction to domestic
political developments. However, there is a general expectation that this move may
represent an overshoot, and some correction is likely in the coming quarter.
Nevertheless, consumption expenditure by households is expected to be the main
driver of growth going forward, and the likely trend over the forecast period is
stronger than previously expected. This is despite headwinds from the VAT and
petrol price increases, as well as slow employment growth. Consumption
expenditure growth is forecast to remain below 2.0% in both 2018 and 2019, but is
expected to reach 2.5% in 2020, compared with 2.1% previously.
Apart from improved confidence, this positive prognosis is supported by lower nearterm inflation, lower interest rates, positive wealth effects, and real wage growth.
Although growth in bank credit extension to households remains subdued and
negative in real terms, a moderate upward trend has been evident since the
beginning of 2017, alongside an improvement in household balance sheets.
Nominal wage growth trends remain more or less unchanged, and upward pressure
on inflation from this source is therefore expected to persist. Nominal average wage
growth is expected to be sticky around the 7.0% level over the forecast period. Real
wage increases are expected to remain positive and in excess of productivity growth.
The outcome of the public-sector wage negotiations is still unclear.


6 First National Bank
MPC Statement May 24th, 2018


Employment trends remain a cause for concern. According to the Quarterly Labour
Force Survey of Statistics South Africa, over the year to the first quarter of 2018,
employment increased by 165 000, mainly in the informal sector of the economy.
While unemployment declined from 27.7% to 26.7%, this was partly due to a marked
increase in discouraged workers, underlining the lack of employment prospects.
The MPC noted the relative stability of the inflation forecast, despite changes in a
number of the key assumptions. As expected, the bottom of the inflation cycle has
been reached, and the trajectory of headline inflation is forecast to remain within the
target range. The April inflation outcome was in line with the SARB’s short-term
forecast and reflected a relatively moderate pass-through from the higher VAT and
sugar tax. The full impact of the VAT increase may still be felt in the coming months.
In contrast with the previous meeting, the MPC assesses the risks to the inflation
forecast to have moved to the upside. This change is mainly due to global
developments. A key uncertainty relates to the outlook for the dollar, which has
appreciated against most currencies. The spillover effects on emerging markets
could become more severe in the event of further significant increases in US bond
yields.
Oil prices also pose an upside risk to the inflation forecast. Current spot prices are
significantly above the levels assumed in the Quarterly Projection Model.
Furthermore, a slight moderation in prices followed by a flat trajectory is assumed in
the coming two years. There may be a degree of upside risk to this assumption.

MPC Statement May 24th, 2018


Greater clarity with regard to electricity tariffs is expected in June when Nersa7 is
scheduled to respond to Eskom’s application for an increase in the order of 30%.
The SARB’s current assumptions are for an 8.0% increase from mid-2019 and a
further similar increase in mid-2020. The possibility of an increase in excess of these
assumptions poses an upside risk to our inflation forecast.
The upside risks identified above are supply-side shocks. As has been noted in the
past, the MPC attempts to ‘look through’ the first-round effects of such shocks and to
react to second-round effects. The evolution of inflation expectations and wage
settlements will be important indicators in this regard.
The growth forecast has improved moderately, mainly for 2019, but remains too low
to make serious inroads into the unemployment rate. The risks to the forecast remain
on the upside, but slightly less so than at the previous MPC meeting. The weak firstquarter growth outcome is not expected to derail the upward trend and does not yet
reflect the renewed business and consumer optimism. Despite the stronger expected
trend in household consumption expenditure, there is still evidence of slack in the
economy, and demand pressures in the economy are not assessed to pose a risk to
the inflation outlook.
In light of the change in the balance of risks to the inflation outlook, the MPC
unanimously decided to keep the repurchase rate unchanged at 6.5% per annum.


7 National Energy Regulator of South Africa
MPC Statement May 24th, 2018


At these levels, the MPC still assesses the stance of monetary policy to be
accommodative and appropriate given the forecast inflation trajectory and the current
state of the economy. However, with risks and uncertainties at high levels, the MPC
will maintain its vigilance to ensure that inflation remains well within the inflation
target range, and will adjust the policy stance should the need arise.
The implied path of policy rates generated by the SARB’s Quarterly Projection Model
reflects one increase of 25 basis points during the final quarter of this year and a
similar increase in mid-2019. Two further increases are indicated in 2020. The
generated path remains a broad policy guide, and the extent to which the MPC
follows it will be determined by, among other things, the MPC’s assessment of the
balance of risks to the forecast.

Lesetja Kganyago
GOVERNOR
The next statement of the Monetary Policy Committee will be released on
19 July 2018.

Contact person:
ZamaNdlovu Ndlovu
012 399 7118