MPC Statement March 28th, 2018


South African Reserve Bank

PRESS STATEMENT
28 March 2018


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 (MPC), the risks to the
inflation outlook have subsided somewhat. Inflation outcomes in recent months have
remained well within the inflation target band, although this likely represents the low
point of the current cycle. While the increase in the value-added tax (VAT) rate to
15% places temporary upside pressure on inflation, this is mitigated by the stronger
exchange rate which has contributed to the changing inflation risk profile. The
affirmation of South Africa’s sovereign rating as ‘investment grade’ and the change
of the outlook from negative to stable by Moody’s Investors Service has contributed
to the recent rand resilience.
The domestic growth outlook is more positive but still challenging. Growth in the
fourth quarter surprised significantly on the upside, and there are signs of increased
business confidence. This is against a backdrop of sustained momentum in the
global economy which provides a favourable environment for emerging markets
generally.
MPC Statement March 28th, 2018


The year-on-year inflation rate, as measured by the consumer price index (CPI) for
all urban areas, measured 4.4% in January 2018 before declining to 4.0% in
February. Goods price inflation moderated from 3.7% to 3.2% while services price
inflation moderated to a seven-year low of 4.9%. The South African Reserve Bank’s
(SARB) measure of core inflation – which excludes food, fuel and electricity –
remained unchanged at 4.1% in February. Year-on-year producer price inflation for
final manufactured goods declined marginally to 5.1% in January.
The inflation forecast of the SARB has shown a moderate improvement despite the
adverse impact of the VAT increase due to be implemented in April. This increase,
combined with base effects and other indirect tax increases, implies that the low
point of the inflation cycle was reached in the first quarter of 2018, at a forecast
average of 4.1%. Headline inflation is expected to average 4.9% in 2018 (unchanged
from the previous forecast), 5.2% in 2019 (down from 5.4%), and 5.1% in 2020. A
peak of 5.5% is expected by the first quarter of 2019 before the VAT increase falls
out of the data. The forecast for core inflation is unchanged at 4.6% for 2018 and is
0.2 percentage points lower, at 4.9%, for 2019. It is expected to remain unchanged
at 4.9% in 2020.
The main changes in the forecast related to the VAT increase and the exchange
rate. The VAT increase is expected to add about 0.6 percentage points to the
headline inflation trajectory for the four quarters from the second quarter of 2018,
with marginal second-round effects persisting into subsequent quarters. The
improved exchange rate has softened the impact of the indirect tax adjustments on
the inflation forecast. The implied starting point for the rand is R11.97 against the
US dollar compared with R12.90 at the time of the previous MPC meeting.
MPC Statement March 28th, 2018


Inflation expectations, as reflected in the survey conducted by the Bureau for
Economic Research (BER) in the first quarter of 2018, are at a multi-year low, having
declined across all groups of respondents. Average expectations for 2018 and 2019
have declined to 5.2% and 5.3% respectively from 5.7% and 5.9% previously, while
an average of 5.4% is expected in 2020. The largest adjustment was seen in the
business category, with downward revisions of around 1 percentage point in both
2018 and 2019. Five-year inflation expectations declined to 5.3%, their lowest level
since they were first surveyed in 2011. Expectations implicit in the break-even
inflation rates (i.e. the yield differential between conventional and inflation-linked
government bonds) declined across all maturities. While these developments are
welcome, the MPC would prefer to see inflation expectations anchored closer to the
midpoint of the target band.
The global economic outlook has remained favourable amid a relatively
synchronised upswing in the advanced economies, although risk and vulnerabilities
remain. The global inflation outlook remains benign but is on a moderate upward
path. However, the recent trade policy actions by the United States (US) could
escalate into a trade war, which could in turn undermine this positive prognosis for
growth and push inflation higher.
The rand has sustained its recent gains since late last year, and some of the key
risks to the outlook have dissipated. Since the previous meeting of the MPC, the
rand has appreciated by 4.8% against the US dollar, by 3.2% against the euro, and
by 3.5% on a trade-weighted basis. At current levels, the SARB’s model assesses
the rand to be somewhat overvalued, and further strengthening potential is probably
limited.
MPC Statement March 28th, 2018


The rand has reacted positively to domestic political developments in the past
months and was given further support following the recent sovereign credit rating
announcement. The risk of a significant sell-off of South African government bonds
by non-residents has therefore receded for now. Further support for the rand comes
from recent dollar weakness. Some widening of the current account deficit is
expected over the forecast period as imports increase in line with higher expected
investment expenditure and the impact of a stronger rand.
A key external risk to the rand remains the possibility of a tighter-than-expected
stance of monetary policy in the US in particular. As anticipated, a moderately faster
pace of tightening was signalled by the US Federal Open Market Committee,
particularly for 2019, and at this stage, further tightening is expected to remain
measured in the absence of significant inflation or growth surprises. Significantly
higher US fiscal deficits could also elicit a stronger monetary policy response. The
pace of monetary policy normalisation in some of the other advanced economies
continues to be gradual with a tightening bias.
The domestic economic growth outlook for this year is more favourable but remains
challenging. This follows an upward revision of historical gross domestic product
(GDP) data and a fourth-quarter outcome of 3.1% which surprised on the upside.
Following an annual growth rate of 1.3% in 2017, the SARB expects a growth rate of
1.7% for 2018 compared with 1.4% previously. The forecast for 2019 is
1.5%, marginally lower than the previous forecast of 1.6%, while a growth rate of
2.0% is forecast for 2020. At these growth rates, the negative output gap, which
measured -1.1% in 2017, is expected to close in 2020. The composite leading
MPC Statement March 28th, 2018


business cycle indicator continued its upward trend in January, consistent with the
improved outlook.
The improved growth outlook is driven primarily by an increase in business and
consumer confidence. This is reflected in the RMB/BER Business Confidence Index,
which increased markedly in the first quarter of 2018 although it remains below the
neutral 50 level. Furthermore, the ‘expected business conditions’ category in the
Absa Purchasing Managers’ Index surged in February to its highest level since 2001.
In this context, growth in gross fixed capital formation is forecast to increase
gradually over the forecast period.
Consumption expenditure by households is also expected to be positively impacted
by the expected increase in consumer confidence, although this is not yet evident in
the consumer confidence surveys. In the near term, consumption expenditure is
expected to be constrained by the tax increases, the lack of compensation for fiscal
drag, weak employment growth as well as subdued growth in credit extension to
households. While consumption expenditure is expected to grow at a slightly slower
rate in 2018 compared with last year, the trend over the forecast period is
moderately stronger than previously expected, reaching 2.1% in 2020. This
improvement is also supported by higher expected wealth growth over the longer
term.
Employment trends remain a concern despite an increase of 102 000 during the past
year. The official unemployment rate was slightly higher when compared to the same
quarter in 2016 while the number of discouraged job seekers increased markedly.
The national Budget presented in February 2018 proposed a faster pace of fiscal
consolidation than that indicated in the October Medium Term Budget Policy
MPC Statement March 28th, 2018


Statement. This revised path is expected to result in a stabilisation of the ratio of
government debt to GDP at about 56% over the medium term. The moderately
tighter stance is due to an overall cut in budgeted expenditure growth as well as an
increase in tax revenues. However, the projected deficits are wider than those
proposed in the February 2017 Budget. The outcome of the ongoing public sector
wage negotiations will be an important indicator of the sustainability of the fiscal
projections and future wage trends.
Nominal wage growth appears to be moderating slightly, but upside pressure on
inflation from this source is expected to persist. Average wage inflation is expected
to decline moderately over the forecast period, from 7.6% in 2017 to 6.8% in 2020,
still positive in real terms.
Annual food price inflation is no longer seen as a major risk to the inflation outlook.
While the continued drought in the Western Cape is likely to adversely affect
agricultural production in the region, the direct impact on food prices is expected to
be fairly limited.
The MPC noted the general improvement in inflation outcomes and the lower
inflation expectations. Although the bottom of the inflation cycle has likely been
reached, the trajectory of headline inflation is forecast to remain within the target
range, with core inflation expected to remain below 5% for most of the forecast
period. To the extent that inflation expectations are adaptive, there may be further
downward adjustment in these expectations in the coming quarters. As mentioned
earlier, the MPC would prefer to see inflation expectations anchored closer to the
midpoint of the target band.
MPC Statement March 28th, 2018


In considering the impact of the VAT increase, the approach of the MPC is to look
through the first-round effects of this increase and focus on the second-round
effects, which are expected to be relatively small. In any event, the policy horizon of
the MPC extends beyond the period during which the first-round effects have an
impact.
The MPC assesses the risks to the inflation forecast to be more or less evenly
balanced. Some of the key domestic risks and uncertainties that overshadowed the
outlook in recent meetings have abated. The government budget was generally well
received, but implementation risks remain. While the recent sovereign ratings
outcome was positive for the rand, further sustained appreciation of the local
currency is not expected. The exchange rate is currently assessed to be less of a
risk to the inflation outlook. However, the rand will remain sensitive to a faster pace
of normalisation in the advanced economies, possible heightened global financial
market volatility, as well as domestic developments.
Although the growth forecast has improved, the outlook remains relatively
constrained. Despite the higher levels of consumption expenditure in the latter part of
2017, demand pressures in the economy are not assessed to pose a risk to the
inflation outlook. The MPC assesses the risks to the growth forecast to be
moderately on the upside. To make an appreciable impact on employment and
potential output, the current improved levels of confidence will need to be sustained
and translate into higher levels of investment. This can only be achieved through a
firm commitment to, and implementation of, credible structural reforms by
government.
MPC Statement March 28th, 2018


The MPC was of the view that, in light of the improved inflation outlook and the
moderation in risks to the forecast, there was some room to provide further
accommodation without undermining the inflation trajectory or the downward trend in
inflation expectations. Accordingly, the MPC has decided to reduce the repurchase
rate by 25 basis points to 6.5% with effect from 29 March 2018. Four members
preferred a reduction while three members preferred an unchanged stance.
In this uncertain environment, future policy decisions will be highly data-dependent
and sensitive to the assessment of the balance of risks to the outlook.
The implied path of policy rates generated by the SARB’s Quarterly Projection Model
has changed since the previous MPC meeting. Whereas previously two to three
increases of 25 basis points each by the end of 2019 were indicated, one increase of
25 basis points is now implied. Two further increases are indicated in 2020. As
emphasised previously, the implied path remains a broad policy guide which can and
does change in either direction between meetings in response to new developments
and changing risks. Therefore, the MPC does not mechanistically respond to
changes in the path.
Lesetja Kganyago
GOVERNOR

The next statement of the Monetary Policy Committee will be released on
24 May 2018.

Contact person:
ZamaNdlovu Ndlovu
MPC Statement March 28th, 2018


012 399 7118