MPC statement 18 January 2018


South African Reserve Bank

PRESS STATEMENT
EMBARGO DELIVERY
18 January 2018


STATEMENT OF THE MONETARY POLICY COMMITTEE

Issued by Lesetja Kganyago, Governor of the South African Reserve Bank
In recent weeks, some of the risks to the inflation outlook have dissipated somewhat.
The rand appreciated following the African National Congress (ANC) elective
conference. Also, Eskom was granted a lower-than-expected tariff increase. While
S&P Global Ratings downgraded South Africa’s long-term local currency sovereign
credit rating to sub-investment grade, Moody’s Investors Service (Moody’s) placed
the country ratings on review for a downgrade. A further downgrade therefore
remains a risk, and will depend on government’s response to the deteriorating fiscal
position and commitment to credible growth-enhancing policies.
Against this more positive backdrop, the inflation forecast has improved despite
continued increases in international oil prices. Near-term inflation is expected to
remain close to the midpoint of the target range. At the same time, domestic growth
outcomes have surprised on the upside, in large part due to the recovery in the
MPC statement 18 January 2018


agricultural sector. While there have been moderate upward revisions to the growth
forecast, the outlook remains challenging.
The year-on-year inflation rate, as measured by the consumer price index (CPI) for
all urban areas, measured 4.6% in November, down from 4.8% previously. Lower
food and fuel price inflation contributed to this decline. Goods price inflation
moderated to 3.7% from 4.1% previously, while services price inflation was
unchanged at 5.5%. The South African Reserve Bank’s (SARB) measure of core
inflation – which excludes food, fuel, and electricity – amounted to 4.4% in October
compared with 4.5% previously.
Year-on-year producer price inflation for final manufactured goods measured 5.1% in
November, up from 5.0% in October. Food products price inflation moderated further
to 0.9% due to strong base effects from lower agricultural prices. Meat price inflation,
however, remains elevated, as the adverse effects of the recent drought continue to
be felt.
The inflation forecast generated by the SARB’s Quarterly Projection Model (QPM)
shows some improvement since November. The average forecast for 2017 is
unchanged at 5.3% but has been revised downwards for 2018 and 2019 to 4.9% and
5.4% respectively from 5.2% and 5.5% previously. Inflation is expected to average
5.5% in the final quarter of 2019. The lower turning point of the forecast is still
expected in the first quarter of 2018 but has been revised down from 4.7% to 4.4%.
The main drivers of the more favourable forecast were the stronger exchange rate
and lower electricity price assumption, following the 5.23% electricity tariff increase
granted to Eskom by the National Energy Regulator of South Africa (Nersa). This
adjustment takes effect from July, when a 6.0% increase is assumed in the CPI
MPC statement 18 January 2018


compared with 8.0% previously. The assumption from mid-2019 remains unchanged
at 8.0%. These effects are countered to some extent by upward adjustments to the
international oil price assumptions, as well as by the impact of the sugar tax on food
prices. This tax is expected to increase food price inflation and headline inflation by
0.6 and 0.1 percentage points respectively in the year following its expected
implementation in April. Food price inflation is now expected to average 5.2% and
6.0% in 2018 and 2019 respectively, up from 4.5% and 5.9% previously.
The core inflation forecast remains unchanged at 4.8% for 2017 but has been
adjusted down to 4.6% and 5.1% in 2018 and 2019 from 5.1% and
5.3% respectively. Whereas previously a lower turning point of 4.6% was expected in
the final two quarters of 2017, a low of 4.4% is now expected in the first quarter of
2018.
The improved forecast for core inflation is driven mainly by the stronger exchange
rate, which is expected to impact favourably on core goods inflation. Higher wage
pressures, by contrast, are expected to keep core services inflation more or less
unchanged. The closing output gap also reduces the degree of downside pressure
on inflation.
Average inflation expectations for 2018, as reflected in the survey conducted by the
Bureau for Economic Research (BER) in the fourth quarter of 2017, declined
marginally from 5.8% to 5.7% but remain close to the upper end of the target range.
Average expectations for 2019 were unchanged at 5.9%, as were the average fiveyear inflation expectations at 5.6%. These moderate moves mask larger adjustments
compared with the third-quarter survey, with business people revising their
MPC statement 18 January 2018


expectations higher over the two years, offsetting the downward adjustment by trade
union officials.
The expectations of market analysts, which are reflected in the Reuters econometer
survey conducted in January, also show a slight improvement since November. The
median forecasts for 2018 and 2019 have declined by 0.1 percentage points to
5.1% and 5.4% respectively while the forecast for 2020 is 5.5%. Inflation
expectations implicit in the inflation-linked bond yields have declined, with the fiveyear break-even inflation rates declining to 5.4%.
The global growth outlook remains positive and relatively synchronised, although
uneven across regions. However, some moderation in growth is generally expected
in 2019. Growth in the United States (US) is expected to be given a boost by the
proposed tax reforms, but the extent of this is still unclear. The euro area recovery
also appears to be sustained, with a persistent decline in the unemployment rate
amid a broad-based firming of fixed capital formation. The recent positive momentum
in Japanese growth is also expected to continue.
These favourable conditions are expected to have a positive spillover effect on
emerging markets in general, with upward growth revisions in most regions, although
less so for Latin America and Africa. Commodity exporters are also expected to
benefit from the recovery in commodity prices. Consensus forecasts suggest that
growth in China will be sustained at current levels despite continued financial stability
risks.
Global inflation trends, by contrast, remain subdued, although there are indications
of emerging upside pressures, driven in part by higher energy prices. Core inflation
pressures are also becoming evident in the US in particular, and are expected to
MPC statement 18 January 2018


intensify gradually should strong growth and labour market tightness persist.
Monetary policies in the advanced economies, particularly in the US and the United
Kingdom (UK), are expected to maintain a moderate tightening bias, while the pace
of withdrawal of monetary accommodation in the euro area and Japan is expected to
be slow. These trends should help sustain capital flows to emerging markets.
The rand exchange rate responded strongly to the outcome of the ANC elective
conference, and since then has traded in a range of between R12.25 and
R12.50 against the US dollar. This is in sharp contrast to the low of R14.47 a month
earlier. Since the previous meeting of the Monetary Policy Committee (MPC), the
rand has appreciated by 13.1% against the US dollar, by 9.6% against the euro, and
by 10.6% on a trade-weighted basis.
In the near term, the rand is expected to remain sensitive to sentiment generated by
political developments. The favourable outlook for capital flows to emerging markets
as well as the positive trade account balances are expected to be supportive of the
rand. The latter is a reflection of the favourable terms of trade and import
compression from lower growth. However, the lingering prospect of a credit ratings
downgrade to sub-investment grade by Moody’s continues to weigh on the longerterm outlook for the rand. Such an event would trigger the exclusion of South African
government bonds from the World Government Bond Index, and is likely to
precipitate significant capital outflows. The extent of the impact on the exchange rate
remains uncertain.
Domestic growth prospects appear to be showing some signs of improvement,
although off a low base. This follows encouraging growth rates in the second and
third quarters of this year, driven to a significant degree by the exceptionally strong
MPC statement 18 January 2018


recovery in the agricultural sector. The SARB has revised its forecast for gross
domestic product (GDP) growth up from 0.7% to 0.9% for 2017, while forecasts for
2018 and 2019 have been adjusted to 1.4% and 1.6% respectively, up from
1.2% and 1.5% previously. This more favourable outlook is consistent with the
further increase in the SARB’s composite leading business cycle indicator of
economic activity in October. The outlook is also likely to be impacted positively
should the recent political developments lead to a sustained boost in business and
consumer confidence.
High-frequency data suggest that fourth-quarter growth is likely to be slower than in
the previous quarter, but still positive. On a month-to-month basis, mining output
increased in October but declined in November, while manufacturing output
increased in both these months. However, the decline in the Absa Purchasing
Managers’ Index (PMI) to 44.9 index points in December is indicative of the
continued challenges faced by the sector. More positively, the sub-index measuring
expected business conditions in six months’ time improved markedly.
Despite the continued weakness in the Rand Merchant Bank (RMB) / BER business
confidence index, growth in real gross fixed capital formation improved in the third
quarter, following a contraction in the previous quarter. All three sectors recorded
growth rates in excess of 4%. The recovery was most pronounced in the private
sector. The durability of this improvement will be highly dependent on the extent to
which the recent political developments impact on confidence and lead to greater
policy certainty and credibility. This process could take some time. At this stage, the
forecast is for minimal growth in gross fixed capital formation this year, with a slight
improvement in 2019.
MPC statement 18 January 2018


A prolonged recovery in fixed capital formation is needed to make inroads into the
official unemployment rate of 27.7%. The Quarterly Employment Statistics survey of
Statistics South Africa shows that, during the third quarter of 2017, formal nonagricultural employment in both the public and the private sectors declined further.
Adjusted for election-related employment by the Electoral Commission of South
Africa (IEC), private-sector employment creation more or less offset public-sector
losses in the four quarters to the third quarter of 2017.
Growth in real final consumption expenditure by households decelerated to an
annualised rate of 2.6% in the third quarter but was characterised by a sharp
increase of 19.9% in expenditure on durable goods, mainly motor vehicles. Some
moderation in consumption expenditure growth is expected in the fourth quarter
following weaker motor vehicle sales. However, the strong ‘Black Friday’ effect
evident in the November retail trade sales may moderate the extent of this
slowdown.
Despite being relatively constrained, the outlook for household consumption
expenditure has improved, with annual average real growth rates of around
1.3% expected over the forecast period. This category is expected to be the main
driver of GDP growth in the short to medium term. Although consumers are likely to
be adversely affected by possible further tax increases, expenditure is expected to
be underpinned by lower inflation and positive real wage increases.
Growth in bank credit extension to households remains weak but has trended slightly
higher in recent months. Much of this increase reflects growth in instalment sale
financing, consistent with improved motor vehicle sales. Growth in credit extension to
MPC statement 18 January 2018


the corporate sector, while more robust, has been on a downward trend for some
time.
Wage pressures are expected to continue contributing to inflation persistence.
Growth over four quarters in nominal remuneration per worker in the formal nonagricultural sector increased from 6.3% in the second quarter of 2017 to 6.8% in the
third quarter. However, adjusting for labour productivity, growth in nominal unit
labour costs declined from 6.1% to 5.5%. Average nominal remuneration increases
are expected to remain above 6% over the forecast period.
International oil prices have continued their upward trend to current levels of around
US$70 per barrel for Brent crude oil. These increases are due to supply restrictions
by some producers, as well as increased global demand. At this stage, it is unclear if
these prices will settle at these elevated levels or if the trend will be reversed by
increased US shale output in response to higher prices. The oil price assumptions in
the QPM have been adjusted upwards to average US$62 per barrel in 2018 and
2019. Domestic petrol prices increased by 71 cents per litre in December but were
reduced by 34 cents per litre (for 95 octane) in January as a result of the stronger
exchange rate. The current over-recovery on the petrol price points to a further price
reduction in February, should current trends persist.
The MPC has taken note of the improved inflation outlook over the near term in
particular. Inflation is expected to reach a low point below the midpoint of the target
range, but is then expected to resume an upward trajectory and measure 5.5% in the
final quarter of next year. This remains above the midpoint of the target range. The
risks to the forecast are still assessed to be on the upside, though the degree of the
upside risk has subsided.
MPC statement 18 January 2018


Two main risks featured prominently in the MPC discussions. First is the prospect of
a sovereign credit ratings downgrade, which would result in three major agencies
rating South Africa’s local-currency debt as sub-investment grade. The impact on the
rand and on long-bond yields could be significant, but the extent to which a universal
downgrade is already priced in remains unclear. Furthermore, the assumption in the
forecast for the starting point of the rand (at R12.90 against the US dollar) is weaker
than current levels.
The response of government to the intensifying fiscal challenges in the upcoming
budget will be key to avoiding this event risk. In addition, the pressures are now even
more intense, with several state-owned enterprises facing financial risks. The
challenge for government will be to find ways to finance the deficit in a growthpositive manner, and at the same time convey a credible commitment to structural
reforms that can raise the potential growth of the economy. This would also support
business and consumer confidence.
The second risk relates to international oil price developments. Although the
assumptions have been raised over the forecast period, the MPC still assesses the
risks to be moderately on the upside, and further upward adjustment may be
required in the future.
Demand pressures are benign, with core inflation pressures relatively contained.
While household consumption expenditure is expected to be supported by positive
wage growth, it remains constrained. The economic growth outlook is also more
positive, but fragile. At this stage, the MPC assesses the risks to the growth forecast
to be more or less balanced.
MPC statement 18 January 2018


The endogenous interest rate path generated by the QPM has changed slightly since
the previous meeting. Whereas three increases of 25 basis points by the end of 2019
were indicated previously, the third increase is now a marginal call. Furthermore, the
timing of the first increase has been pushed out to later in the period. The implied
path remains a broad policy guide and could change in either direction by the next
meeting in response to new developments and changing risks.
In light of the recent developments and the balance of risks, the MPC has decided
that it would be appropriate to maintain the current monetary policy stance at this
stage. Accordingly, the repurchase rate remains unchanged at 6.75% per annum.
Five members preferred an unchanged stance, while one member preferred a
25 basis point reduction.

Lesetja Kganyago
GOVERNOR

The next statement of the MPC will be released on 28 March 2018.

Contact person:
ZamaNdlovu Ndlovu
012 399 7118