South African Reserve Bank

PRESS STATEMENT
EMBARGO DELIVERY
18 September 2014


STATEMENT OF THE MONETARY POLICY COMMITTEE

Issued by Gill Marcus, Governor of the South African Reserve Bank

Since the previous meeting of the Monetary Policy Committee the domestic
inflation forecast has improved slightly, but the inflation trajectory remains
uncomfortably close to the upper end of the target range. At the same time the
domestic economic growth outlook has deteriorated further, with declining growth
in both consumption expenditure and gross fixed capital formation, as confidence
remains low. The combination of stubborn inflation and a sluggish growth outlook
continues to pose a difficult dilemma for monetary policy.

The global environment has been characterised by increased financial market
volatility, following heightened speculation relating to the timing and extent of US
monetary policy normalisation. This impacted on emerging market currencies in
general, and on the rand in particular. This was further illustrated after
yesterday’s FOMC meeting, which reaffirmed the gradual pace of US monetary
MPC Statement September 18th, 2014


policy normalisation, and its data dependent nature. However, despite increased
political instability and significant risks in a number of regions, the international oil
price has declined along with continued weakness in global food prices,
contributing to a more benign global backdrop for the domestic inflation outlook.

The year-on-year inflation rate as measured by the consumer price index (CPI)
for all urban areas surprised on the upside at 6,4 per cent in August, having
measured 6,6 per cent and 6,3 per cent in June and July 2014 respectively. The
higher turnout was mainly due to higher-than-expected food prices, which had
been anticipated to continue their recent downward trend. Downward pressure
was exerted by petrol prices which increased by 5,8 per cent, down from 8,3 per
cent in July. The categories of food, housing utilities and transport together
accounted for 3,8 percentage points of the inflation outcome in August,
unchanged from the previous month. Core inflation, which excludes food, petrol
and electricity, increased to 5,8 per cent, from 5,7 per cent in July, driven mainly
by the impact of the weaker exchange rate on some goods categories.

Administered price inflation excluding petrol measured 6,5 per cent, up from the
6,4 per cent in July. The headline producer price inflation for final manufactured
goods, which reached a recent high of 8,8 per cent in April, measured 8,1 per
cent and 8,0 per cent in June and July respectively, driven in part by lower
agricultural product inflation.

MPC Statement September 18th, 2014


The Bank’s forecast of headline inflation is slightly more favourable than that
presented at the previous meeting, mainly a result of lower expected food and
petrol price pressures. Whereas for some time inflation had been forecast to
peak at an average of 6,6 per cent in the fourth quarter of this year, the peak now
appears to have occurred in the second quarter, at an average of 6,5 per cent.
Inflation is now expected to average 6,2 per cent in 2014, compared with 6,3 per
cent previously, and 5,7 per cent in 2015, (5,9 per cent previously), and to return
to within the target range in the first quarter of 2015 instead of the second quarter
as previously forecast. The inflation forecast for 2016 increased to 5,8 per cent
from 5,6 per cent, mainly as a result of the revised electricity price assumption
following the review of Eskom tariffs by Nersa. The revised assumption makes
provision for electricity price increases of 11,6 per cent from July 2015 and again
from July 2016.
The forecast for core inflation is unchanged at an average 5,6 per cent and 5,7
per cent in 2014 and 2015 respectively, reaching a peak of 5,8 per cent in the
first quarter of 2015, and moderating to 5,5 per cent in 2016. As before, the MPC
sees the risks to the headline inflation forecast to be skewed to the upside, with
possible renewed pressure coming from the exchange rate.
Inflation expectations, as reflected in the survey conducted by the Bureau for
Economic Research at Stellenbosch University in the third quarter of 2014, have
again remained more or less unchanged, and anchored at around the upper end
of the target range. Inflation is expected to average 6,2 per cent in 2014 and 6,1
per cent and 6,0 per cent in 2015 and 2016 respectively. As usual, there is a
MPC Statement September 18th, 2014


fairly wide dispersion of expectations between the different categories of
respondents. While business people expect inflation to average 6,4 per cent in
2015 and 2016, analysts’ expectations average 5,7 per cent and 5,4 per cent.
Expectations of trade unionists are for 6,2 per cent in both years, and all
categories of respondents expect inflation in the current year to average 6,2 per
cent. Household inflation expectations for 2014 remained unchanged at 6,3 per
cent.
The global growth recovery remains asynchronous amid sustained improvements
in the US and UK, and deteriorating prospects in the Eurozone and Japan.
Although growth in the US is not expected to exceed the 2,2 per cent achieved in
2013, this is mainly a result of the contraction during the first quarter of this year.
Real output growth of 4,2 per cent was recorded in the second quarter of 2014,
and consensus forecasts are for growth rates of around 3 per cent in the next two
quarters. Similar growth rates are expected in 2015. At the same time the
unemployment rate has been declining at a faster pace than previously
anticipated. While the growth outlook for the UK remains positive, possible
downside risks could emerge should Scotland vote for independence from the
United Kingdom.
Growth in the Eurozone has remained weak, with the German economy also
under pressure following a contraction in the second quarter. Sanctions on
Russia are expected to be an additional constraint affecting the Eurozone’s
growth outlook. Although the Japanese economy appears to be recovering from
the VAT-induced slump in the second quarter, the recovery looks fragile.
MPC Statement September 18th, 2014


While emerging Asia appears to be benefiting most from the US recovery,
emerging markets generally are facing increasing headwinds. Signals coming out
of China continue to be mixed, amid a sharp slowdown in industrial production in
August. Latin American economies also face a challenging outlook, particularly in
Argentina, Venezuela and Brazil, which is currently experiencing a technical
recession. Growth in sub-Saharan Africa is expected to remain relatively strong,
although commodity producers may be adversely affected by lower commodity
prices and possible spillover effects from the Ebola outbreak.
There is a continued absence of significant upside global inflation risks, despite
pressures experienced in some emerging markets. The various indicators of US
inflation remain well contained below the 2 per cent level, while the fear of
deflation in the Eurozone persists. Declining international oil and food prices,
along with a number of other commodity prices, are expected to reinforce the
current benign global inflation environment.
The divergent growth outlooks in the advanced economies are likely to be the
main drivers of monetary policy developments. The UK is expected to tighten
monetary policy early next year. The stronger performance of the US labour
market has led to heightened speculation that normalisation may begin earlier
than previously anticipated. These expectations resulted in an appreciation of the
US dollar against most currencies, as well as rising long-term US Treasury yields
ahead of yesterday’s FOMC meeting. At yesterday’s press conference the FOMC
Chair reaffirmed the view that policy normalisation will occur gradually, but is
contingent on no surprises to employment growth or inflation in either direction.
MPC Statement September 18th, 2014


The data dependent nature of the forward guidance means that changes in the
outlook for inflation, unemployment and growth are likely to lead to bouts of
global financial market uncertainty in advance of FOMC meetings in the coming
months.
At the same time, however, the ECB has loosened monetary policy and has
indicated its willingness to embark on some form of quantitative easing should
this be necessary. Monetary policy is also expected to remain accommodative for
some time in Japan. Since the previous meeting of the MPC, policy rates have
been reduced in the Eurozone, Israel, South Korea, Chile and Hungary, and
increased in Russia and New Zealand.
Following a few weeks of relative stability, the rand exchange rate weakened in
the past few days in response to US dollar strength, as well as the widening
deficit on the current account of the balance of payments to 6,2 per cent of GDP.
Since the previous meeting of the MPC, the rand initially traded in a range of
R10,50 and R10,75 against the US dollar, but has weakened since early
September reaching a low of R11,07. On a trade-weighted basis, however, the
rand depreciated by 0,4 per cent, having appreciated against the euro and the
British pound. The rand is expected to remain sensitive to changes in sentiment
regarding possible changes in US policy which will affect the appetite for
emerging market assets generally, as well as to possible impacts from
geopolitical risks and domestic factors.
MPC Statement September 18th, 2014


Since the previous MPC, non-residents have been net sellers of bonds to the
value of R29,3 billion, but this has been offset in part by net purchases of equities
to the value of R16,2 billion over the same period. Year to date there have been
net outflows of bonds and equities to the value of R6,3 billion. These trends
indicate that financing of the current account through portfolio inflows is likely to
become increasingly challenging.
The current account deficit in the second quarter of 2014 was wider than
generally expected by the markets, following the 4,5 per cent of GDP recorded in
the first quarter. This widening was a result of increased dividend outflows, lower
dividend inflows following a large once-off inflow during the first quarter, and
weak export growth, impacted to some extent by the platinum strike. Export
growth in the third quarter is expected to remain constrained by the slow return to
full capacity production by the platinum mines and the strike in the steel and
engineering sector in July, which had significant spillover effects on the
manufacturing sector in general. The current account is anticipated to narrow
gradually over time.
The domestic economic growth outlook remains weak following growth rates of
-0,6 per cent and 0,6 per cent in the first and second quarters of the year
respectively. These growth rates are well below potential output growth and
indicative of a widening output gap. Partly as result of this outcome, as well as
the expected impact of the metal workers strike in July, the Bank’s forecast for
GDP growth for 2014 has been revised down further to 1,5 per cent, from 1,7 per
cent previously, with the risks still assessed to be on the downside. The forecasts
MPC Statement September 18th, 2014


for both 2015 and 2016 have been revised down by 0,1 percentage points, to 2,8
per cent and 3,1 per cent respectively. The Bank’s leading indicator of economic
activity continues to trend sideways, consistent with a subdued growth outlook.
Business confidence, as reflected in the RMB/BER business confidence index,
remains negative despite a five index point increase to 46 in the third quarter.
Adding to prevailing concerns are indications from Eskom that electricity supply
constraints may be more severe and endure for longer than previously expected.
The near-term outlook for mining remains subdued, with platinum production not
expected to return to full capacity before the end of the year. In July, mining
production recorded a broad-based year-on-year decline of 7,7 per cent, but a
0,9 per cent increase on a month-to-month basis. Manufacturing output declined
significantly in July, recording year-on-year and month-to-month contractions of
7,9 per cent and 5,4 per cent respectively, largely due to the impact of the fourweek strike in the steel and engineering sub-sector. Capacity utilisation in the
sector declined from 82,1 per cent in the first quarter of 2014 to 80,6 per cent in
the second quarter. More positively, the Kagiso PMI reflected some improvement
in sentiment in August, with the index rising 3,1 index points to 49, marginally
below the neutral level, while the construction sector has recorded growth rates
of 5 per cent in the first two quarters of the year.
Growth prospects have been constrained by the weakening trend in gross fixed
capital formation which grew at an annualised rate of 0,5 per cent in the second
quarter. Real fixed capital expenditure by both the public corporations and the
private sector contracted during the quarter. Of particular concern is the
MPC Statement September 18th, 2014


continued downward trend over the past three quarters in private sector
investment, despite higher capital outlays in the manufacturing sector. This has
been reflected in the continued slow pace of employment creation in the private
sector and the rise in the unemployment rate to 25,5 per cent in the second
quarter of 2014.
Consumption expenditure by households also continued its moderating trend
which began in the first quarter of 2012, amid declining real disposable income
growth. Annualised growth of 1,5 per cent was recorded in the second quarter of
2014. The slowdown was particularly marked in the durable and semi-durable
goods categories, probably impacted by the prolonged strikes in the mining and
manufacturing sectors. Retail trade sales contracted by 0,9 per cent in June on a
month-to-month basis, but increased by 1,2 per cent in July, higher than
generally expected. Wholesale trade sales contracted by 5,2 per cent month-tomonth in July, and by 4,6 per cent year-on-year. Domestic vehicle sales have
also slowed. Given the above, somewhat surprisingly the FNB/BER consumer
confidence index increased from -6 to +4 in the second quarter.

Trends in credit extension to households are consistent with the weak growth in
household consumption expenditure, showing a further divergence between
credit extension to households and to the corporate sector. Growth in total loans
and advances over the year measured 9,7 per cent in July, with lending to the
corporate sector increasing by 17 per cent, and to households by 4,1 per cent.
The latter reflects continued sluggish growth in mortgage credit extension and
MPC Statement September 18th, 2014


tighter credit criteria for unsecured lending in particular. Twelve-month growth in
general loans to households, which is mainly unsecured lending, reached a low
of 0,2 per cent in July, while growth over three months exhibited an annualised
contraction of 2,5 per cent. This decline is across all income groups, but more
pronounced at the lower levels. A positive development is that household debt to
disposable income moderated from 74,4 per cent in the first quarter to 73,5 per
cent in the second quarter.

Growth in corporate sector borrowing during the first half of the year was
dominated by the agricultural sector, electricity supply (renewable energy
projects) as well as wholesale and retail trade sectors. The cost of bank funding
appears to have increased recently as a result of changed regulatory
requirements relating to the implementation of Basel III, the impact of the bail-in
of certain African Bank Limited creditors and the consequent rating action by
Moody’s Investor Service, all of which could result in tighter funding conditions.

No new wage and unit labour cost data have been released since the previous
meeting of the MPC, although settlements in the steel and engineering sector
and the clothing sector have been well above current and expected inflation
rates. The MPC remains concerned about the apparent delinking of wage
demands and some wage settlements from underlying inflation and productivity
growth trends, as well as the possible impact of forthcoming wage negotiations,
including in the public sector. These concerns relate to settlements at all levels,
MPC Statement September 18th, 2014


including executive pay. Excessive wage settlements could have adverse
impacts on employment, inflation, the general competitiveness of the economy
and the profitability and viability of small businesses in particular.

Notwithstanding the 9,5 per cent increase in July, food price inflation is expected
to slow over the coming months. Pipeline pressures from agricultural prices
continue to moderate following sharply lower maize prices since March, while
manufactured food price inflation declined to 8,5 per cent in July compared with
9,5 per cent in April. International food prices, as reflected in the FAO
international food price index, declined for the fifth consecutive month in August
in response to positive maize and wheat supply conditions. These developments
are expected to impact favourably on domestic consumer prices, although base
effects are likely to interrupt the declining year-on-year trend in the final months
of the year.

International oil prices declined in recent weeks, having traded in a range of
between US$105-US$114 per barrel for the year to the end of July. Since
August, the price has fallen below this range and is currently trading at around
US$98 per barrel. This is despite rising tensions and instability in the Middle East
and conflict in the Ukraine, events that in the past would likely have resulted in an
oil price spike. As a result of this lower price, the domestic petrol price was
reduced by 67 cents per litre in September, having been unchanged in August. At
this stage there is an average over-recovery on the petrol price due to the lower
MPC Statement September 18th, 2014


international price, but the favourable impact is being partially offset by continued
rand weakness.

Despite the slight near-term improvement in the inflation outlook and the
relatively stable inflation expectations, the MPC is concerned that the forecast
remains uncomfortably close the upper end of the target band. Given the upside
risks to the forecast, the proximity to the upper end of the band makes the
inflation outcomes highly vulnerable to changes in inflationary pressures.

A key upside risk is the exchange rate, which is vulnerable to the slow pace of
adjustment to the current account deficit, as well as to the uncertainty
surrounding the future path of monetary policy in the advanced economies. At
this stage it is difficult to assess the extent to which normalisation of US monetary
policy is already priced in to the rate.

The MPC remains concerned about the risks of a wage-price spiral, should
settlements well in excess of inflation and productivity growth become the
economy-wide norm. Such developments could also undermine South Africa’s
international competitiveness and delay the current account adjustment.
The deterioration in the longer term inflation trajectory relative to the previous
forecast is a result of the revised tariff increases granted to Eskom by Nersa. The
view of the Committee is that such relative price adjustments should not be
reacted to automatically. However, while the focus of monetary policy should be
MPC Statement September 18th, 2014


on the second round effects of these increases, this is complicated given the
multi-year nature of the adjustment.
While inflation is the primary focus of the Committee, the MPC is also mindful of
the anaemic state of the domestic economy, rising unemployment and the
downside risk to its growth forecast. Domestic expenditure has deteriorated
further, particularly private sector fixed capital formation, and, together with
continued moderation in household consumption expenditure, is indicative of the
lack of demand pressures in the economy.
The MPC is still of the view that interest rates will have to normalise over time.
However, given the slightly improved inflation outlook notwithstanding the upside
risks, the stable inflation expectations and the downside risks to the weak growth
outlook, the MPC has decided that the repurchase rate will remain unchanged at
5,75 per cent per annum.
Despite the 75 basis point increase so far this year, monetary policy remains
accommodative, and will continue to be supportive of the domestic economy
subject to achieving its primary inflation targeting objective. Future decisions will,
as always, be highly data dependent.

Gill Marcus
GOVERNOR

Contact person:
Candice Jeffreys
+27 12 313 4209


MPC Statement September 18th, 2014