South African Reserve Bank

PRESS STATEMENT
EMBARGO DELIVERY
20 November 2014


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 sharp decline in
international oil prices has contributed to a more benign global inflation environment.
This development may also ameliorate the deteriorating growth outlook in some
regions by providing a boost to consumption expenditure. Lower oil prices have also
had a favourable impact on domestic headline inflation, with the medium-term
forecast improving relative to the previous forecast. However, the underlying
inflation pressures, as reflected in core inflation, persist.

The domestic growth outlook remains challenging, but after two quarters dominated
by the fall-out from extended strikes, some recovery is expected, but demand
remains subdued. The coming quarters are expected to see an improved
performance in the mining and manufacturing sectors, but the outlook is inhibited by
domestic structural constraints, as well as by a weak global economy and the
continued declining trend in non-oil commodity prices. Growth next year is expected
to remain weak.

The year-on-year inflation rate as measured by the consumer price index (CPI) for all
urban areas measured 5,9 per cent in both September and October, having
measured 6,4 per cent in August. Downward pressure on inflation in October came
from continued moderation in food and petrol prices. Food price inflation continued
its downward trend, measuring 8,0 per cent in October, down from 8,7 per cent
previously, while petrol prices increased by 2,4 per cent. Core inflation, which
excludes food, petrol and electricity, moderated to 5,6 per cent in September from
5,8 per cent in August, but measured 5,7 in October, reflecting primarily continued
exchange rate pass-through to some goods categories.

Administered price inflation excluding petrol measured 6,4 per cent in October, down
from 6,5 per cent in September. Headline producer price inflation for final
manufactured goods, which reached a recent high of 8,8 per cent in April, measured
7,2 per cent and 6,9 per cent in August and September respectively, driven in part by
lower food and fuel price inflation.

The Bank’s forecast of headline inflation has improved since the previous meeting of
the MPC, mainly due to the impact of declining international oil prices. Having
reached a peak of 6,5 per cent in the second quarter of this year, inflation is now
expected to average 5,9 per cent in the final quarter of 2014, and average 6,1 per
cent for the year, compared with 6,2 per cent previously. The downward trend is
expected to continue into next year, with inflation forecast to reach a low of 5,1 per
cent in the second quarter, and to average 5,3 per cent for the year, compared with

5,7 per cent previously. The forecast for 2016 has been revised down from 5,8 per
cent to 5,5 per cent, and is expected to measure 5,4 per cent in the final quarter of
the year.

The forecast for core inflation, by contrast, is more or less unchanged at an average
5,6 per cent and 5,7 per cent in 2014 and 2015 respectively, reaching a peak of 5,9
per cent in the first quarter of 2015 (previously 5,8 per cent), and moderating to 5,3
per cent in 2016, down from 5,5 per cent previously. The MPC assesses the risk to
the headline inflation forecast to be broadly balanced.

The results of the fourth quarter inflation expectations survey of the BER will only be
released in December. Market-based surveys, as reflected in the Reuters
Econometer survey, however, show that the median CPI inflation expectation of
analysts has remained unchanged over the past two months at 5,7 per cent and 5,5
per cent for 2015 and 2016 respectively. Break-even inflation rates (the yield
differential between conventional government bonds and inflation linked bonds)
declined since the previous meeting and reflect expectations within the target range
for 5 year maturities, and marginally above the upper limit of the inflation target
range at 10 year maturities.
The US and the UK remain the main drivers of global growth although more broadly,
global growth may get some impetus from lower oil and food prices, which should
provide some boost to consumers. US economic growth was better than expected in
the third quarter, with the first advanced estimate of 3,5 per cent, and the
unemployment rate declining to 5,8 per cent, the lowest level since June 2008. The
UK recorded growth of 2,8 per cent in the third quarter, while the unemployment rate

was unchanged at 6,0 per cent. The Japanese economy contracted for a second
consecutive quarter during the third quarter, and has prompted a reconsideration of
a further VAT increase next year. The response to the further additional monetary
stimulus announced recently remains uncertain amid a tighter fiscal policy stance.
The Eurozone outlook also remains bleak, including in the core countries such as
France and Germany, although lower food and oil prices, coupled with further
monetary easing may have a positive impact.
The outlook for emerging markets is mixed, with emerging Asian economies
expected to benefit most from the positive spillovers from the US recovery. This is
expected to offset in part the adverse impact of the slowdown in China, where
growth is expected to be lower than in the past few years, as the economy
rebalances away from investment towards consumption. This moderation is
expected to continue to impact negatively on commodity prices. The Indian economy
is showing signs of sustained recovery, while the other Brics partners, Russia and
Brazil, face significant growth headwinds. Oil exporters generally are expected to
face challenges from international oil price weakness.
Global inflation is expected to moderate in the face of benign food price inflation and
falling international oil and other commodity prices. While this is welcome in the
higher inflation regions, particularly emerging markets, it does aggravate deflationary
risks in some of the advanced economies, particularly in the Eurozone and Japan.
Monetary policy stances are expected to remain ultra-loose in these two regions,
with a significant stimulus package announced recently in Japan and the ECB is
anticipated to conduct further asset purchases. The US Fed has ended its
programme of quantitative easing, but at this stage it is not contracting its balance

sheet and proceeds from maturing assets are being reinvested. Although the general
expectation is that the US Fed will begin raising interest rates in mid-2015, there are
also some expectations that the more benign inflation outlook could delay this.
Forward guidance from both the Bank of England and the US Fed is that any
adjustment is likely to be gradual, and policy rates may be lower than their estimated
long run normal rates for some time despite the improved growth outlooks. Since the
previous meeting of the MPC, policy rates have increased in Brazil, Russia and
Indonesia, but reduced in Sweden, South Korea, Chile and Poland.
The exchange rate of the rand has been relatively volatile since the previous
meeting, in response to external and domestic factors including changing
expectations of the timing of the first US interest rate increase as well as the
downgrade of South Africa’s credit rating by Moody’s Investor Service. Although the
rand initially weakened sharply against the US dollar, at one stage reaching a level
of R11,36 against the US dollar, this move has since largely been reversed. Since
the previous meeting of the MPC, the rand has depreciated marginally against the
US dollar, but appreciated by 2,1 per cent and 3,5 per cent against the euro and
sterling respectively, and by 1,8 per cent on a trade weighted basis.
The rand is expected to remain susceptible to sudden shifts in sentiment regarding
changes in monetary policy stances in the advanced economies, and the continued
uncertainty regarding the extent to which US normalisation is already priced in to the
exchange rate. The asynchronous nature of advanced economy monetary policies is
expected to complicate the outlook and outcomes. However, the rand is likely to
remain more sensitive to changes in financial conditions in the US than in Japan and
the Eurozone. The persistently slow adjustment of the current account deficit also

makes the rand vulnerable to swings in sentiment that raise concerns about the
financing of this deficit. Although the lower oil prices should reduce the oil import bill,
its positive impact on the deficit may be limited by further declines in other
commodity prices.
The volatility in portfolio capital flows is indicative of fickle global investor sentiment.
Net bond sales by non-residents amounted to R12,6 bn in September and R2,1 bn in
October and a further R1,5 bn to date in November. In the equities market, having
been marginal net sellers in September, non-residents were net buyers to the value
of R5,7 bn in October but net sellers of R6,3 bn to date.
The domestic growth outlook remains subdued. Although an improved growth
outcome is expected in the third quarter, following the 0,6 per cent growth in the
second quarter, this is off a low base following prolonged strikes in the mining and
manufacturing sectors. The Bank’s forecast for GDP growth in 2014 has declined
marginally from 1,5 per cent to 1,4 per cent, and forecasts for 2015 and 2016 have
been revised down from 2,8 per cent and 3,1 per cent to 2,5 per cent and 2,9 per
cent respectively. This restrained outlook is consistent with the Bank’s composite
leading indicator of economic activity which continues to trend sideways, with a slight
upward move recently. The RMB/BER business confidence index improved in the
third quarter, but at 46 index points, remains below the neutral level of 50.
The mining sector appears to be recovering to some extent from the strike-affected
first half of the year, and is expected to contribute positively to third quarter growth,
following two consecutive quarters of contraction. The physical volume of mining
production increased by 0,7 per cent in the third quarter compared with the second
quarter, and further increases can be expected in the final quarter, as platinum

output is still below pre-strike levels. By contrast, although the physical volume of
manufacturing production increased in September, the month-long strike in the steel
and engineering industry in July contributed to a quarter-to-quarter contraction of 1,3
per cent in the third quarter. Sentiment indicators suggest that the outlook for the
sector remains bleak, with the manufacturing confidence index still at very low levels
and capacity utilisation rates back at 2011 levels. More positively, the Kagiso PMI
edged above 50 index points in October for the first time since March, driven mainly
by the inventory and new sales orders sub-indices.
The outlook for the construction sector is more positive, with the real value of
building plans passed increasing for the fourth successive month in August. On a
three-month-to-three-month basis, an increase of 9,8 per cent was recorded.
However, while the various building confidence indices have generally improved,
they remain below the neutral level.
The weak pace of economic growth is mirrored in the unemployment rate, which,
according to the Quarterly Labour Force Survey of Statistics South Africa measured
25,4 per cent in the third quarter, compared with 24,5 per cent a year earlier. Total
employment increased at a year-on-year rate of 0,5 per cent in the quarter. At the
same time the number of discouraged workers increased sharply, by almost
100,000, and now total 2,5 million.
Consumption expenditure by households has remained relatively subdued, but there
are signs of a moderate increase in the quarterly growth rate, as the negative effects
of the protracted strikes on consumption dissipate. Consumption expenditure could
be positively impacted by lower petrol prices. Although retail sales growth declined
by 0,8 per cent (non annualised) in September, quarter-to-quarter growth of 0,9 per

cent was recorded in the third quarter, and 2,3 per cent year-on-year. Similarly,
wholesale trade sales contracted in the third quarter, but increased by 5,9 per cent
on a year-on-year basis. Motor vehicle sales have also shown some signs of
recovery, although domestic sales are expected to be lower this year than in 2013.
Retail sector confidence improved, with the BER reporting retailer confidence above
the neutral level for the first time in two and a half years. Consumer confidence,
however, declined significantly in the third quarter following an unexpected increase
in the second quarter.
Trends in bank credit extension to the private sector have remained characterised by
declining growth in advances to households, while advances to corporates have
been buoyant. Total loans and advances grew at a twelve month rate of 8,8 per cent
in September, but excluding mortgages the growth rate was 13,5 per cent, compared
with a recent high of 18,6 per cent in December 2012. Credit extension to the
household sector grew by 3,7 per cent in September, as unsecured lending
remained weak despite a reversal of the negative growth trend in the month, but
credit to the corporate sector grew by 15,3 per cent. Twelve-month growth in
mortgage advances to households remained at levels below 3 per cent, while
instalment sale credit and leasing finance continued its downward trend, with growth
of 6,9 per cent. These trends are likely to constrain consumer demand in the coming
months.
According to the October Medium Term Budget Policy Statement, government
remains committed to its policy of fiscal consolidation, in order to prevent an increase
in the debt ratio to unsustainable levels. The fiscal deficit is expected to decline from
a projected 4,7 per cent of GDP in the current fiscal year to 3,0 per cent in 2017/18.

This is expected to be achieved through adherence to a nominal expenditure growth
ceiling, and increased tax revenues. The ability to achieve the nominal expenditure
targets will be determined to an important degree by the public sector wage
settlement.
Wage trends remain broadly unchanged since the previous meeting of the MPC.
According to Andrew Levy Employment publications, wage settlement rates
averaged 8,0 per cent in the first nine months of the year. Nominal remuneration per
worker as well as productivity trends in the formal non-agricultural sector were
distorted by the significant increase in temporary employees by the Independent
Electoral Commission, which contributed to the decline in the year-on-year increase
in remuneration from 6,3 per cent to 3,5 per cent, while productivity declined by 1,6
per cent. The net result was a marginal increase in unit labour costs of 5,2 per cent
in the second quarter, from 5,1 per cent previously.
Food price inflation remains a major driver of inflation, but is expected to continue to
moderate in the coming months. Food price inflation appears to have peaked at 9,5
per cent in August, and has since moderated to 8,0 per cent in October, as lower
producer prices of crops and cereals, which declined by 6,3 per cent in September,
are beginning to have an impact at the consumer price level. Restocking of herds
following the drought last year, however, has kept meat price inflation elevated. Food
price pressures also remain benign at the global level, with the Food and Agricultural
Organisation international food price index declining for seven consecutive months to
its lowest level since August 2010.
International oil prices have declined markedly since their recent peak in June of
around US$115 per barrel to current levels of below US$80 per barrel. This decline

reflects a combination of factors, including increased supply coming from the US and
Libya, moderating demand from China in particular, and changes in the internal
dynamics within the OPEC cartel. The general expectation in the market is that these
lower prices could persist for some time. Although some of the advantage of lower
international oil prices has been offset to some extent by a weaker rand exchange
rate, domestic petrol prices have declined by a cumulative R1,17 per litre since
August, and should current trends continue, a further decline of around 70 cents per
litre can be expected in December.

The marked decline in international oil prices has had a significant impact on the
medium term outlook for headline inflation in the global economy and in South Africa.
At this stage it is unclear whether this is a temporary shock, or if it will be sustained
or decline further. As with an oil price increase, we would look through the impact
effect and focus on the possible second round effects of this decline. The possibility
that oil prices are sustained at current levels introduces a degree of downside risk to
the inflation forecast.
The domestic growth outlook remains challenging, and the risks to the forecast are
assessed to be moderately on the downside. The MPC does not see significant
signs of excess demand pressures that are impacting on the inflation outlook and
household consumption expenditure is expected to remain constrained.
At the same time, despite its recent relative stability, the exchange rate remains an
upside risk to the inflation outlook, vulnerable to changing perceptions of the timing
of global monetary policy adjustments, and the slow pace of contraction in the
current account deficit. The extent to which policy normalisation is already priced
into the exchange rate is also unclear.

A further upside risk to the inflation forecast comes from a possible increase in wage
settlement rates in excess of inflation and productivity growth in the coming year.
In light of this assessment, the MPC sees the overall risk to the headline inflation
forecast to be more or less balanced. However, given the elevated level of core
inflation, and the fact that headline inflation is expected to increase later in the
forecast period as the first round effect of the oil price decline dissipates, the
Committee remains vigilant and will continue to monitor developments closely.
The Committee remains of the view that interest rates will have to normalise over
time. However, given the lower trajectory of headline inflation and the continued
weak state of the economy, the MPC has unanimously decided to keep the
repurchase rate unchanged at 5,75 per cent per annum at this stage.
The timing of future interest rate increases will be dependent on a range of factors,
including the evolution of inflation expectations, the speed of normalisation of
monetary policy in the US and the state of the domestic economy.

Lesetja Kganyago

GOVERNOR

Contact person:
Candice Jeffreys
+27 12 313 4209