MPC Statement September 21st, 2017


South African Reserve Bank

PRESS STATEMENT
EMBARGO DELIVERY
21 September 2017


STATEMENT OF THE MONETARY POLICY COMMITTEE

Issued by Lesetja Kganyago, Governor of the South African Reserve Bank
The South African economy recorded positive growth during the second quarter of
2017 following two consecutive quarters of contraction. Growth prospects, however
remain subdued as domestic fixed investment contracted further amid low business
confidence. The inflation forecast has increased marginally since the previous meeting
of the MPC, with increased uncertainty regarding a number of the main drivers.
The global economy is on a recovery path. Inflation has moderated in the emerging
economies and remains benign in most advanced economies. The FOMC statement
yesterday confirmed the gradual pace of reduction of its balance sheet and
normalisation of its policy rate. Along with continued accommodative policies by the
ECB, this is expected to contribute to the continuation of favourable prospects for
capital flows to emerging economies.

MPC Statement September 21st, 2017


The year-on-year inflation rate as measured by the consumer price index (CPI) for all
urban areas increased to 4.8% in August, up from 4.6% previously, marginally below
the Bank’s short-term forecast. Food and non-alcoholic beverage inflation surprised
on the downside, moderating from 6.8% to 5.7%. Meat prices continued to accelerate
in August, having measured 15.0%, but the lower cereal prices contributed to the
slowing momentum. The Bank’s measure of core inflation, which excludes food, fuel
and electricity, measured 4.7% in July and 4.6% in August in line with the short-term
forecast.
Year-on-year producer price inflation for final manufactured goods declined from 4.0%
in June to 3.6% in July. Food products price inflation moderated further, to 3.3% in
July, but the divergent trend of manufactured meat prices continued with an increase
of 17.8%. This trend was also evident in agricultural prices, where the subcategory of
“live animals” increased by 31.7%, while “products of crops and horticulture” declined
by 26.9%.
The Bank’s forecast for headline CPI inflation is unchanged at an annual average of
5.3% in 2017, and revised up by 0.1 percentage point to 5.0% and 5.3% in 2018 and
2019. A lower turning point of 4.6% is still expected in the first quarter of 2018. The
same pattern is observed in the forecast for core inflation which is unchanged at 4.8%
for 2017, but adjusted up to 4.9% and 5.0% for the next two years. These forecasts
do not incorporate the most recent inflation outcome.

The main drivers of these changes are a lower repurchase rate, a less appreciated
exchange rate assumption, a slightly narrower output gap and a marginal adjustment
to the food price forecast as meat prices continue to surprise on the upside. Food price
MPC Statement September 21st, 2017


inflation is forecast to reach a low turning point of 4.8% in the first quarter of 2018, and
to average 7.3% in 2017, and 5.2% and 5.6% in 2018 and 2019. There may be some
downside risk to this forecast in light of the August food inflation outcomes. The
electricity tariff assumption remains unchanged at 8.0% from July next year, but there
may be some upside risk to this assumption, given Eskom’s recent application to
Nersa.
Inflation expectations as reflected in the survey conducted by the Bureau for Economic
Research at Stellenbosch University in the third quarter of 2017 continue to be
relatively anchored at the upper end of the target range. Despite a decline of 0.2
percentage points in the average expected inflation for 2017 to 5.7%, expectations
remain unchanged at 5.8% and 5.9% for the next two years. Expectations of analysts
and business people moderated - although the latter remain above the target range -
while those of trade unionists increased marginally. A welcome development is that
average 5-year inflation expectations declined from 5.9% to 5.6%. This is the lowest
level recorded since long-term expectations were first surveyed in 2011. Expectations
implicit in the difference between nominal bonds and inflation-linked bonds are more
or less unchanged since the previous meeting, with the 5-year break-even rate at
5.2%.

Global conditions remain generally favourable despite some geopolitical risks. The
upswing appears to be synchronised, with increased world trade volumes. Growth in
the US is forecast to remain above potential in the short to medium term, with the
devastation caused by the recent hurricanes expected to have only a limited and shortlived impact on growth. The improved growth performance in the euro area also
appears to be sustained and region-wide, while the Japanese economy has
MPC Statement September 21st, 2017


experienced moderate growth in the past few quarters. By contrast, growth in the UK
has slowed, following weak investment in the face of the Brexit headwinds. The
outlook for emerging markets is also relatively positive amid generally improving
fundamentals.

Despite the improved growth outlook, global inflation pressures remain benign,
particularly in the advanced economies. These trends are likely to contribute to the
persistence of accommodative monetary policy stances in Japan and the euro area,
where the recent appreciation of the euro is likely to dampen inflation pressures
further. As expected, the US Fed yesterday announced a gradual reduction of its
balance sheet. The process had been communicated previously and was largely
priced in by the financial markets. The pace of policy rate normalisation is also
expected to remain measured, as inflation continues to surprise on the downside,
despite tightening labour market conditions. The stance of US fiscal policy is a source
of uncertainty. Although tax reductions could lead to a faster pace of monetary
tightening, the prospect of significant tax reforms has receded over time.

The rand exchange rate traded in a range of between R13.54 and R12.74 since the
previous meeting of the MPC, driven in part by movements in the major currencies.
Over this period, the rand depreciated by 2.8% against the US dollar, by 6.2% against
the euro, and by 4.5% on a trade-weighted basis. The rand remains sensitive to
political developments, weak economic growth prospects and the risk of further
sovereign ratings downgrades. However, it has been supported by persistent trade
account surpluses and associated narrowing of the current account deficit.

MPC Statement September 21st, 2017


The rand has also been supported by the relatively accommodative global monetary
policy settings. These have contributed to sustained demand for high-yielding
emerging market bonds. Net purchases by non-residents of South African government
bonds have amounted to R(63) billion year to date. The domestic yield curve relative
to other peer emerging market economies remains attractive to non-residents despite
a decline in the curve across all maturities. However, longer-term bond yields and the
rand remain vulnerable to a large non-resident sell-off in the event of further credit
ratings downgrades resulting in South Africa falling out of the global bond indices.

The domestic economic growth outlook remains constrained despite the higher-thanexpected growth outcome of 2.5% in the second quarter of this year. This broad-based
improvement, while welcome, is not expected to have a significant impact on the
annual growth outcome. The Bank’s forecast for GDP growth for 2017 has been
revised up marginally from 0.5% to 0.6%, while the forecasts for 2018 and 2019 have
remained unchanged at 1.2% and 1.5%. This outlook is consistent with the Bank’s
leading business cycle indicator which has been weakening since the beginning of the
year, indicative of muted growth prospects. Business confidence also remains at very
low levels, despite the slight improvement in the RMB/BER Business Confidence
Index during the third quarter.

All the major sectors, apart from construction, recorded positive growth in the second
quarter, with a particularly strong performance in the agricultural sector. The recovery
in the manufacturing sector followed three successive quarterly contractions, while the
tertiary sector reversed its one quarter contraction. The limited monthly data for the
third quarter present a mixed picture at this stage. Mining sector output contracted in
MPC Statement September 21st, 2017


July while manufacturing recorded positive growth. However, the Absa PMI has
averaged 43.5 index points in the first two months of the quarter, suggesting continued
headwinds for the sector.

The underlying weakness in the economy is evident in the 2.6% contraction in gross
fixed capital formation during the second quarter. Of particular concern is the 6.9%
decline in private sector fixed investment, reflecting the low levels of business
confidence. This subdued outlook is expected to persist against a backdrop of
continued political and policy uncertainty.

These investment trends do not bode well for employment creation in the economy.
Total employment declined in the second quarter of 2017 and the unemployment rate
remained unchanged at 27.7%. The public sector, previously the main source of
employment growth in the economy, is likely to continue to shed jobs as fiscal
constraints intensify.

Consumption expenditure by households rebounded strongly in the second quarter
following the sizeable contraction in the previous quarter. Spending on all three major
goods components recovered, but expenditure on services contracted. Despite the
improved outcome, the outlook for consumption expenditure growth remains subdued,
although positive, amid very low levels of consumer confidence. Month-on-month retail
trade sales decreased in July, but motor vehicle sales remained relatively strong in
July and August. The Bank expects household consumption growth to be in the region
of 1% for this year.

MPC Statement September 21st, 2017


The underlying drivers of household consumption expenditure remains unchanged.
Lower inflation, lower interest rates and higher real income growth are expected to
provide some support for consumption. Offsetting effects include depressed consumer
confidence, weak employment growth, the absence of significant wealth effects, and
the prospect of further tax increases in the wake of fiscal revenue shortfalls.

In addition, growth in credit extension to the private sector has declined steadily over
the past few months, as corporate demand for mortgage finance and general loans in
particular moderated. Growth in credit extension to households remains weak and
negative in real terms. These trends are also reflected in continued household
deleveraging, with household debt to disposable income declining further to 72.6% in
the second quarter, its lowest level since the beginning of 2006.

International oil prices have increased by about US$5 per barrel since the previous
meeting, with Brent crude oil currently trading at around US$55 per barrel.
Nevertheless, the MPC does not expect a further sustained acceleration in prices as
the flexibility of US shale oil production is expected to provide a ceiling to prices. The
previous oil price assumptions therefore remain unchanged. The domestic price of
95 octane petrol has increased by a cumulative 86 cents per litre since August,
mainly due to higher international product prices. A further moderate increase is
expected in October.


MPC Statement September 21st, 2017


The MPC expects inflation to remain within the target range over the forecast period,
closer to the mid-point than was the case early in the year. Core inflation has remained
relatively stable, indicative of the absence of significant demand pressures. However,
a number of risks to the inflation outlook have increased and the MPC assesses the
risks to the inflation outlook to be somewhat on the upside.
The rand remains a key upside risk to the inflation outlook. Furthermore, some of the
event risks, particularly those of a political nature, are now more imminent but with no
greater degree of clarity regarding the outcome. The prospect of a further ratings
downgrade persists, particularly given the increased fiscal challenges and political
uncertainty. The narrower current account deficit and the global environment remain
supportive of the rand. However, should inflation and/or growth surprise on the upside
in Europe and in the US in particular, we could see a faster pace of monetary
tightening, which could impact on capital flows and the rand exchange rate. At this
stage, the markets appear to be pricing a high probability of an increase in the Federal
funds rate in December, and three further increases next year.
A further upside risk relates to the possibility of a large electricity tariff increase than
is currently assumed in our forecast from July next year. A tariff increase of 20% could
raise the headline inflation forecast by between 0.2 and 0.3 percentage points, and
the MPC will continue to assess the possible second round effects of these increases.
The MPC remains concerned that inflation expectations of business people and trade
unions remains above or close to 6% for the next two years even though our own
forecast and those of most analysts expect inflation to be much closer to 5%. Lower
MPC Statement September 21st, 2017


inflation expectations among key price setters is an important element in reducing
inflation in the future, thus enabling lower nominal interest rates.

Until August, food price inflation had been moderating at a slower pace than expected,
mainly due to the continued acceleration in meat prices. However, the August yearon-year outcome surprised significantly on the downside. Should this lower trajectory
continue, there could be a downside risk to the food price forecast, and to the overall
inflation outlook, particularly in the short term.

Although household consumption expenditure rebounded strongly in the second
quarter, the MPC does not view this as indicative of the longer-term trend of
expenditure, which is expected to remain constrained. The second quarter growth
outcome, while positive, does not change our growth forecast significantly, and the
outlook remains weak. The MPC assesses the risks to the revised growth forecast to
be slightly on the downside.
In light of these developments and the deteriorating assessment of the balance of the
risks, the MPC has decided to keep the repurchase rate unchanged at 6.75% per
annum. Three members preferred an unchanged stance and three members preferred
a 25 basis point reduction. Ultimately the committee decided to keep the rate
unchanged.
Given the heightened uncertainties in the economy, the MPC felt it would be
appropriate to maintain the current monetary policy stance at this stage, and reassess
the data and the balance of risks at the next meeting.

MPC Statement September 21st, 2017


Lesetja Kganyago
GOVERNOR

Contact person:
ZamaNdlovu Ndlovu
012 399 7118