South African Reserve Bank

Press Statement
Embargo on Delivery
28 January 2016


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 deteriorated significantly, mainly due to exchange rate and food price
developments. The rand has depreciated considerably in response to domestic and
external developments, while the impact of the worsening drought on food prices is
becoming increasingly evident. The outlook is complicated by the fact that the
domestic growth outlook has weakened further. The global backdrop has also
become more challenging particularly for emerging markets, and downside risks to
the sustainability of the recovery in the advanced economies have increased.

The year-on-year inflation rate as measured by the consumer price index (CPI) for all
urban areas measured 5,2 per cent in December, up from 4,8 per cent in November.
This increase was broadly in line with market and the Bank’s expectations, and
reflected in part the delayed response of food price inflation to the impact of the
drought on agricultural prices. Food and non-alcoholic beverages inflation
accelerated to 5,9 per cent, up from 4,8 per cent previously and contributed 0,9

percentage points to the overall CPI outcome. Goods price inflation increased to 4,6
per cent from 3,8 per cent previously mainly due to higher petrol and food prices,
while services price inflation remained unchanged at 5,7 per cent. The Bank’s
measure of core inflation, which excludes food, fuel and electricity, remained
relatively stable at 5,2 per cent, up from 5,1 per cent in November.
Producer price inflation for final manufactured goods increased from 4,3 per cent in
November to 4,8 per cent in December. The category of food, beverages and
tobacco products contributed 2,1 percentage points to the December outcome.
The latest inflation forecast of the Bank shows a marked deterioration. Having
averaged 4,6 per cent in 2015, inflation is now expected to average 6,8 per cent in
2016 and 7,0 per cent in 2017. This compares with the previous forecast of 6,0 per
cent and 5,8 per cent for these years. Inflation is still expected to breach the upper
end of the target in the first quarter of 2016, but is now expected to remain outside
the target for the entire forecast period. A peak of 7,8 per cent is expected in the
fourth quarter of 2016 and the first quarter of 2017, followed by a moderation to 6,2
per cent in the final quarter of that year (5,7 per cent previously). The changes in the
forecast are mainly due to a significantly more depreciated real exchange rate
assumption, and higher expected food price inflation. These upward revisions more
than offset the impact of the lower international oil price assumption. The electricity
price assumption remains unchanged from the previous meeting.
The forecast for core inflation has also deteriorated, although to a lesser degree than
that for headline inflation. Core inflation is expected to breach the upper end of the
target range for four consecutive quarters from the third quarter of 2016, with a peak
of 6,4 per cent in the final quarter of 2016 and the first quarter of 2017. This measure

is expected to average 6,0 per cent in 2016, and 5,9 per cent in 2017, and to
moderate to 5,5 per cent by the final quarter of next year. The deterioration in the
forecast is mainly due to the more depreciated exchange rate assumption and
expected higher unit labour costs.
Inflation expectations as reflected in the survey conducted by the Bureau for
Economic Research show a marginal upward movement for 2016 but a more
pronounced deterioration for 2017, with average inflation expectations increasing
from 5,9 per cent to 6,2 per cent, mainly due to the changes in expectations of trade
union officials. Five-year inflation expectations edged up to 6,1 per cent, also mainly
due to changes in the expectations of trade union officials. This survey was
concluded prior to the depreciation of the rand in December, so the outcome of the
next survey will be closely monitored.
The impact of the rand exchange rate weakness on market forecasts is evident in
the changes to the Reuters Econometer survey between December and January.
Median inflation expectations were stable in November and December, at 5,9 per
cent and 5,8 per cent for 2016 and 2017, but increased in January to 6,0 per cent
and 6,1 per cent. The median forecast for 2018 is 5,7 per cent. Break-even inflation
rates also increased significantly across all maturities, with the 5-year maturities
rising to current levels of around 7,3 per cent.
The global growth outlook appears to have worsened somewhat in recent weeks,
contributing to a correction in global equity markets. Although most of the downward
revisions to global growth have been due to the deteriorating prognosis for emerging
markets, more recently the risks of a slowdown in the US have increased, amid
declining consumer expenditure, and the impact of low oil prices and a strengthening

dollar on business investment. However, despite the fourth quarter slowdown,
growth of around trend is still generally expected. While the recovery in the euro area
remains modest, the growth forecasts for the UK and Japan have generally been
revised down.
Emerging market growth prospects, particularly for commodity-producing countries,
remain constrained amid persistent capital outflows. The outlook is heavily
influenced by the slowing Chinese economy but there are conflicting views as to
whether a hard landing can be expected. There is also uncertainty regarding the
efficacy of policy reforms that have been undertaken. Perceptions of the
modifications to the renminbi exchange rate regime as well as equity market volatility
have added to this uncertainty.
Global inflation pressures remain benign, reinforced by a further decline in
international oil prices, but there have been upward revisions in some emerging
markets. Monetary policies in most advanced economies are expected to remain
accommodative. The slow pace of normalisation in the US is expected to continue,
but further easing is expected in Japan and the euro area, while the Bank of England
has indicated that monetary policy tightening is still some way off. Divergent
monetary policy paths are also expected in the emerging markets. Commodity
importers with sound macroeconomic fundamentals have scope for further easing,
while some commodity producers, particularly those experiencing exchange rateinduced inflationary pressures, have been in a tightening mode, despite slowing
growth.
The exchange rate of the rand depreciated markedly since the previous meeting of
the MPC, contributing significantly to the deterioration in the inflation forecast. Since

the previous meeting, the rand has depreciated by 13,5 per cent against the US
dollar, by 15,2 per cent against the euro, and by 12,9 per cent on a trade-weighted
basis. The muted reaction of the exchange rate to the start of US Fed normalisation
suggested that this move was more or less priced in, but this was overshadowed by
the impact of domestic developments on the exchange rate earlier in the month.
In early January, the rand reacted further to growing concerns about the outlook for
the Chinese economy. While most emerging market currencies were affected, since
the previous meeting of the MPC, the rand’s depreciation has been in excess of
most of its emerging market peers. Other indicators such as widening credit spreads
and the sharp increase in domestic bond yields point to a higher risk premium
attached to South African assets.
Although at current levels the rand may appear to be undervalued, divergences from
equilibrium can persist for some time. Furthermore, the current account adjustment
remains slow, with the deficit expected to widen further in the face of continued
weakness in commodity prices and higher drought-induced agricultural imports. The
financing of the deficit will also be more challenging in an environment of persistent
capital outflows from emerging markets. Since the previous meeting, non-residents
have been net sellers of South African bonds and equities.
From a monetary policy perspective, a key risk to the inflation outlook is not only the
possibility of further depreciation, but also the extent to which the there is a change
in the pass-through dynamics, which have been relatively muted in recent years.
The domestic economic growth outlook remains weak, with further downward
revisions to the Bank’s forecast. Growth in 2015 is estimated to have averaged
around 1,3 per cent, and is expected to moderate to 0,9 per cent in 2016, before

accelerating to 1,6 per cent in 2017. This compares with the previous forecast of 1,5
per cent and 2,1 per cent for 2016 and 2017. The Bank’s estimate of potential output
growth was revised down from 1,9 per cent to 1,5 per cent for 2016, and from 2,1 per
cent to 1,6 per cent for 2017. Although there was a marginal increase in the Bank’s
leading business cycle indicator in November, the trend remains negative, consistent
with the subdued outlook. The RMB/BER business confidence index declined further
in the fourth quarter of 2015, to its lowest level in five years.
High frequency data indicate that the mining sector remains under pressure in the
face of declining commodity prices and weak demand. Despite a recovery in the third
quarter, the manufacturing sector outlook remains negative. Capacity utilisation has
declined further and the Barclays PMI, which has remained well below the neutral
level for some months, is consistent with a contraction in the fourth quarter. The
continuing drought also means that near-term respite for the agricultural sector is
unlikely.
Underlying this growth outlook is the continued low growth in gross fixed capital
formation, with private sector investment contracting in the third quarter. The
prospects for formal sector employment growth therefore remains bleak: the
Quarterly Employment Statistics survey of Statistics South Africa reports static
employment levels over the four quarters to the third quarter of 2015.
Growth in consumption expenditure by households also moderated in the third
quarter, with contractions in spending on durable and non-durable goods. Domestic
motor vehicle sales reflected this weakness although recent retail sales data,
particularly with respect to semi-durable goods, suggest there may have been a
modest improvement in the final quarter of last year. However, the decline in the

FNB/BER consumer confidence index in the fourth quarter of 2015 to a fourteen year
low suggests that household consumption expenditure is likely to remain
constrained.
Credit extension to households has increased marginally recently, particularly with
respect to mortgage and general loans. However, these increases remain low and
negative in real terms, while instalment sale credit continues to slow. Tighter
National Credit Act Regulations related to affordability assessments became
effective from September, and are expected to constrain credit to households further.
While credit extension to corporates remains robust, it is relatively narrow-based,
and reflects in part increased demand for mortgage loans by property funds.
Wage and salary trends continue to contribute to the persistence of inflation at higher
levels. Year-on-year growth in nominal salaries and wages, while lower in the third
quarter of last year, was still above the upper end of the inflation target range. After
adjusting for labour productivity increases, growth in total unit labour costs slowed
marginally to 5,0 per cent in the third quarter. Andrew Levy Employment Publications
reported an average wage settlement rate in collective bargaining agreements of 7,7
per cent in 2015.
Food prices remain a significant risk to the inflation outlook. The surge in agricultural
commodity prices since early 2015 is beginning to impact on consumer food price
inflation, and these pressures are likely to increase in the light of the persistent
drought and the weaker exchange rate. This is despite continued moderation in
global food prices. Although previous forecasts had incorporated an expectation of
higher food price inflation, recent adverse developments have resulted in a further

deterioration of the Bank’s food price forecast, which is now expected to peak at
around 11 per cent in the fourth quarter of this year.
International oil prices have declined to multi-year lows since the previous MPC
meeting. The global oversupply and consequent low prices are expected to persist in
the short term, particularly following the lifting of sanctions against Iran. But with
marginal producers expected to shut down or reduce production, prices are expected
to follow a moderate upward trend over the forecast period. The impact of this
upward trend on domestic petrol prices has contributed to the higher inflation
forecast in 2017 in particular. The potentially favourable impact of the international oil
price decline on domestic petrol prices has been more or less offset by the
depreciation of the rand. Petrol prices have declined only marginally since
November, and the current under-recovery suggests a possible increase of around 7
cents per litre in February.
Previously the Committee expressed concerns about the growing risks to the
inflation outlook, mainly due to exchange rate and food price risks. These risks
appear to be materialising and have contributed to the significant deterioration of the
inflation forecast. The intensity of the drought has brought about a sizeable revision
to the Bank’s food price outlook, while the exchange rate has depreciated
significantly more than expected. While oil prices have a moderating impact on the
inflation outlook in the near term, base effects and the assumed upward trajectory
contribute to the adverse inflation outlook in 2017. The forecast also incorporates
changes in administered prices, in particular for water, while an upside risk remains
regarding electricity tariff increases.

The MPC assesses the risks to the inflation outlook to be relatively balanced. While
there may be potential for further rand weakness in the short-term given the negative
outlook for emerging markets in general as well as domestic factors, the lower
observed exchange rate pass-through remains a mitigating factor. However, there is
still uncertainty as to the sustainability of this low pass-through, particularly in the
face of large nominal exchange rate movements as recently experienced. The
upside risk from the exchange rate is more or less offset by the downside risks from
the international oil price assumptions and projected food price inflation.
Demand pressures remain constrained, and the focus of the MPC will therefore be
on the evolution of inflation expectations and indications of second-round effects of
the exogenous shocks to the inflation outlook. There are some indications that
inflation expectations may have deteriorated, but the extent of this will become more
evident in the coming surveys. The trend in core inflation provides some indication of
the possible emergence of second-round effects. Although core inflation has
remained relatively contained in recent months, it is expected to accelerate and to
exceed the upper end of the inflation target range for some time in response to
exchange rate and wage pressures.
The Committee faced the continuing dilemma of a deteriorating inflation environment
and a worsening growth outlook. The risks to the growth outlook are assessed to be
on the downside, despite the downward revision to the forecast.
Given the deterioration in the inflation outlook, the MPC decided to increase the
repurchase rate by 50 basis points to 6,75 per cent per annum, effective from 29
January 2016. Three members supported a 50 basis point increase, two members
preferred a 25 basis point increase, while one member preferred no change.

The MPC still views the stance of monetary policy to be accommodative. Despite the
rate increase, the real repurchase rate remains low given the higher expected
inflation over the period. The MPC will remain focused on its core mandate of
containing inflation within a flexible inflation targeting framework. As noted on a
number of occasions in the past, the MPC is of the view that the growth constraints
facing the economy are primarily of a structural nature and cannot be solved solely
by monetary policy. Nevertheless, the MPC remains sensitive, to the extent possible,
to the possible negative impact of monetary policy actions on cyclical growth. As
before, future moves will be highly data dependent.

Lesetja Kganyago

Governor

Contact person:
Candice Jeffreys
+27 12 313 4209