MPC Statement July 20th, 2017


South African Reserve Bank

PRESS STATEMENT
EMBARGO DELIVERY
20 July 2017


STATEMENT OF THE MONETARY POLICY COMMITTEE

Issued by Lesetja Kganyago, Governor of the South African Reserve Bank
Since the previous meeting of the Monetary Policy Committee the inflation outlook has
improved. Food price inflation has moderated faster than expected, domestic demand
pressures remain subdued and international oil prices have declined. Despite a
degree of volatility, the rand exchange rate has been relatively resilient in the face of
expected monetary policy tightening in some advanced economies, as well as
domestic political risks and uncertainties. Risks to the inflation outlook still remain.
At the same time, domestic growth prospects have deteriorated further following the
surprise GDP contraction in the first quarter of 2017. The economy has now recorded
two successive quarters of negative growth, and although a near-term improvement is
expected, the outlook remains challenging. A number of sentiment indicators and data
points have reached levels last seen during the 2009 recession, at the height of the
global financial crisis.
MPC Statement July 20th, 2017


The year-on-year inflation rate as measured by the consumer price index (CPI) for all
urban areas measured 5.4% and 5.1% in May and June, in line with the Bank’s shortterm forecast. Food and non-alcoholic beverage inflation measured 6.9% in both
months, with the contribution to the overall inflation outcome unchanged at 1.2
percentage points. Meat prices continued to accelerate, and at 13.0%, contributed to
the downside stickiness of food price inflation. The Bank’s measure of core inflation,
which excludes food, fuel and electricity, measured 4.8% in both months.
Producer price inflation for final manufactured goods measured 4.6% in April and 4.8%
in May. The further moderation in food prices was reflected in the PPI with the category
of food products, beverages and tobacco products decelerating for the seventh
consecutive month to 5.8%. The divergent trends between the subcategories of
“products of crops and horticulture” and “live animals” persisted, with year-on-year
changes of -24.4% and 21.4% respectively.
The Bank’s forecast for headline CPI inflation has shown a marked improvement since
the previous meeting. The annual average forecast has been revised down by 0.4
percentage points in 2017 and 2018, and by 0.3 percentage points in 2019, to 5.3%,
4.9% and 5.2%. A lower turning point of 4.6% is expected in the first quarter of 2018
(previously 5.1%), and an average of 5.2% is forecast for the final quarter of 2019.
The main drivers of the improved forecast were the lower starting point; revised
assumptions regarding international oil prices, domestic electricity tariffs and the real
effective exchange rate; and a wider output gap. These assumptions are set out in the
annexure to this statement. Food price inflation is also expected to be more subdued,
due to a lower starting point and more favourable domestic crop estimates. Despite a
persistent upward trend in meat price inflation, the forecast for food price inflation has
MPC Statement July 20th, 2017


been revised down from 7.7% to 7.3% for this year; and from 5.4% to 5.1% in 2018.
The forecast for 2019 is unchanged at 5.5%.
The improvement is also evident in the core inflation outlook, with average forecasts
of 4.8% for 2017 and 2018, and 4.9% for 2019. This compares with previous forecasts
of 5.0%, 5.1% and 5.3% for these years. This improvement is driven in part by lower
unit labour costs, in addition to the exchange rate and output gap developments.
Inflation expectations as reflected in the survey conducted by the Bureau for Economic
Research show a marginal improvement, with average expectations slightly below 6%
in all three years. The decline was most marked among analysts, particularly over the
first two survey years, and to a lesser extent among labour unionists. Both these
categories of respondents expect inflation to be within the target range over the
forecast period. The expectations of business respondents are largely unchanged and
remain above 6% for all three years. By contrast, average 5-year expectations of all
groups edged up from 5.7% to 5.9%, and ranged between 5.5% for analysts and 6.3%
for business respondents.
Median inflation expectations of market analysts improved over the near term.
According to the Reuters Econometer survey conducted in July, expected inflation
declined by 0.2 percentage points to 5.5% in 2017 and to 5.3% in 2018, compared
with the May survey. However, the longer term trend is reversed with an expectation
of 5.5% in 2019. Expectations implicit in the difference between nominal bonds and
inflation-linked bonds have also declined slightly since the previous meeting, with the
5-year break-even rate at 5.3%.
The global growth backdrop remains positive, with sustained upswings evident in most
regions. This is despite continued uncertainty regarding economic policy reforms in
MPC Statement July 20th, 2017


the US. Nevertheless, growth rates and potential output estimates are still generally
lower than those in the pre-crisis period. While there are lingering concerns about
financial stability risks from the shadow banking sector in China, the recent strong
performance of the economy has contributed to the favourable environment for
emerging markets.
Underlying global inflation trends remain benign, with inflation below target in most of
the advanced economies, notwithstanding the positive growth prognosis and
tightening labour markets. An exception is the UK where inflation has accelerated in
the wake of the Brexit-induced depreciation of sterling. The subdued global inflation
outlook is reinforced by generally slow wage and productivity growth in developed
economies.
Despite the absence of inflationary pressures, central banks in a number of advanced
economies have signalled intentions to move from highly accommodative monetary
policy stances. These countries include the US, the UK, the euro area and Canada.
This process is unlikely to be smooth or perfectly synchronised and could generate
bouts of uncertainty. In the US, expectations of further near-term rate increases by the
Fed have been scaled down following a succession of downside inflation surprises.
The gradual nature of the planned balance sheet contraction by the Fed has also been
well communicated and appears to be largely priced in by the markets.
While changing expectations regarding ECB and US monetary policy in particular have
impacted on a number of emerging market currencies and bond yields, the reaction
has been relatively muted, and a repeat of the 2013 so-called taper tantrum episode
is not expected. Those economies that were most sensitive to that episode have much
improved macroeconomic balances, and their currencies are less vulnerable to
MPC Statement July 20th, 2017


possible spill-over effects from gradual monetary tightening in the advanced
economies.
The rand has also been affected by these changing expectations, as well as by
domestic political developments, including concerns about a proposal to change the
SARB’s monetary policy mandate. While the rand is more or less unchanged since the
previous meeting of the MPC, it has been relatively volatile, having fluctuated in a
range between R12.60 and R13.60 against the US dollar.
The rand’s relative resilience had been underpinned by the generally positive
sentiment towards emerging markets, as well as by sustained trade surpluses. The
current account deficit is still expected to widen over the forecast period, but the
degree of widening has been revised down. The rand remains vulnerable to increased
global risk aversion, domestic political shocks, and to the possibility of further ratings
downgrades.
The domestic growth outlook remains a concern, following the surprise broad-based
GDP growth contraction during the first quarter of this year. With the exception of the
primary sector, all sectors recorded negative growth. While positive growth is expected
in the second quarter, the Bank’s annual growth forecasts have been revised down
further. The forecast for 2017 has been adjusted down from 1.0% to 0.5%, and the
forecast for 2018 is down from 1.5% to 1.2%. Growth of 1.5% is expected in 2019,
compared with 1.7% previously.
As a result of these trends, the output gap has widened somewhat despite a further
downward revision to potential output growth by 0.3 percentage points for each year,
to 1.1% in 2017 and rising to 1.3% in 2019. The weak outlook is consistent with the
decline in the RMB/BER Business Confidence Index to levels last seen during the
MPC Statement July 20th, 2017


recession following the global financial crisis. The SARB’s composite leading business
cycle indicator has also moderated somewhat since January.
Monthly data for both the mining and manufacturing sectors in April and May suggest
that, in the absence of a sharp contraction in June, these sectors are likely to contribute
positively to growth in the second quarter, along with the continued rebound in the
agricultural sector. The recovery is nevertheless expected to be modest, particularly
in the light of a sharp fall in the ABSA Purchasing Mangers’ Index in June, which
returned to below the neutral level of 50 index points. The construction sector also
remains under pressure following the marked fall in building plans passed in the first
quarter of this year, with the negative trend continuing into April.
The continued poor performance of gross fixed capital formation contributes to the
weak state of the economy. Although private sector investment recorded positive
growth after five consecutive quarters of contraction, at a growth rate of 1.2% it
remains very subdued. Given the extremely low level of business confidence, a nearterm improvement is unlikely. Policy uncertainty, a recent example being in the mining
sector, is likely to constrain investment.
As a consequence, employment growth has been minimal, and the prospects are
unfavourable. Given the need for fiscal consolidation, a continued decline in
government’s contribution to employment creation is expected. The official
unemployment rate increased to 27.7% in the first quarter of this year.
Consumption expenditure by households contracted in the first quarter of this year,
amid a further deterioration in consumer confidence. Although the monthly retail sales
data suggest a more positive outcome for the second quarter, this improvement is
likely to be offset in part by a decrease in new vehicle sales in the quarter. The outlook
MPC Statement July 20th, 2017


for consumption expenditure is expected to remain weak, amid employment
uncertainty and higher tax burdens.
These consumption trends are mirrored in the continued moderation in credit
extension to households. Growth in mortgage advances and instalment sales credit
finance remained subdued, reflective of the difficult conditions in the housing and
vehicle markets. General loans to households increased moderately in May, but off a
low base. Credit extension to the corporate sector, by contrast, remains relatively
buoyant, but on a downward trend.
Wage trends have been an important contributor to the persistence of inflation at
higher levels. There are, however, indications of some moderation in average salaries,
and related unit labour costs, which are expected to remain below the 6% level over
the forecast period. The outcome of a number of multi-year wage agreements that are
due for renewal in 2017 will be closely watched as they could pose a risk to the inflation
trajectory.
The persistent global oil supply glut, along with increased shale gas production in the
US, have undermined efforts by OPEC and other producers to support prices through
output restrictions. Since the beginning of June, Brent crude oil prices have traded at
levels below US$50 per barrel, and the Bank’s oil price assumptions have been
revised down over the forecast period. These recent oil price trends, along with the
stronger exchange rate, contributed to a 69 cent per litre reduction in the petrol price
in July. Following a weakening of the rand and a partial recovery in crude oil prices, a
moderate petrol price increase is expected in August.

MPC Statement July 20th, 2017


The inflation outlook has improved significantly since the previous meeting of the MPC and
has been fairly broad-based. The lower core inflation outlook is indicative of weaker underlying
inflation pressures, at a time when the impact of exogenous shocks on headline inflation has
been dissipating. These shocks include drought-induced food price inflation and to a lesser
extent international oil price increases earlier this year that have since been reversed.
A number of risks to the inflation outlook persist and the MPC assesses the risks to the inflation
outlook to be broadly balanced. Although the rand has been relatively resilient, it remains
vulnerable to heightened political uncertainty, global monetary policy developments and
possible further credit ratings downgrades. On the positive side, it is supported by a sustained
narrowing of the current account deficit and positive investor sentiment towards emerging
markets.
A further upside risk relates to the possible supply side shock of a large electricity tariff
increase from July next year. Eskom has approached Nersa for an increase of around 20%,
but the current forecast assumes an increase of 8%. This assumption will be adjusted in line
with any new determinations made by Nersa.
The MPC also remains concerned that inflation expectations remain sticky at the upper end
of the target range. To the extent that these expectations are formed adaptively, they should
adjust downwards if the lower inflation trajectory is sustained. The MPC would prefer
expectations to be anchored closer to the mid-point of the target range.
Underlying demand in the economy is extremely weak and the MPC is concerned about the
deterioration in the growth outlook over the forecast period. This decline is broad-based. It is
unclear where the drivers of accelerated growth will come from in the absence of credible
structural policy initiatives that will reduce uncertainty and increase business and consumer
confidence. The MPC assesses the risks to the revised growth forecast to be slightly on the
downside.
MPC Statement July 20th, 2017


Given the improved inflation outlook and the deteriorated growth outlook, the MPC has
decided to reduce the repurchase rate by 25 basis points with effect from 21 July 2017, to
6.75% per annum. Four members preferred a reduction, while two members preferred an
unchanged stance.
As we have emphasised on numerous occasions, the MPC does not view monetary policy as
the solution to the structural growth constraints in the economy. Nor does it believe that a
reduction in interest rates will provide a significant stimulus to growth in the current
environment of low confidence and political uncertainty. It will however provide some relief at
the margin.
In this highly uncertain environment, future policy decisions will be dependent on data
outcomes and our assessment of the balance of risks. We remain vigilant and would not
hesitate to reverse this decision should the inflation outlook and risks deteriorate.

Lesetja Kganyago
GOVERNOR

Contact person:
ZamaNdlovu Ndlovu
012 399 7118