T T Mboweni: Monetary and economic trends in South Africa
Statement of the Monetary Policy Committee by Mr T T Mboweni, Governor of the South African
Reserve Bank, at the South African Reserve Bank, Victoria, 13 October 2005.
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Introduction
For the past two years, CPIX inflation has been within the inflation target range of 3-6 per cent. In
recent months, however, oil price developments have posed an increasing risk to the continued
attainment of the inflation target and since the last meeting of the Monetary Policy Committee, CPIX
inflation has risen by 1,3 percentage points. These increases were in line with expectations, and our
current forecasts show that we should remain within the target range over the forecast period. More
recently there has been some respite in the oil market, and prices have moderated from recent peaks
caused by hurricanes Katrina and Rita. However, oil prices remain at high levels and continue to be of
concern.
Despite the petrol price increases, the economy continues to perform at a robust pace, domestic
demand remains strong, and formal sector employment has increased.
Recent inflation developments
Inflation as measured by the consumer price index for metropolitan and other urban areas excluding
the interest cost on mortgage bonds (CPIX) reached a low of 3,1 per cent in February and then began
to increase, mainly as a result of petrol price movements. After measuring 3,5 per cent in June, CPIX
inflation increased to 4,2 per cent and 4,8 per cent in July and August respectively. During these two
months, the petrol price increased by a total of R0,56. Excluding petrol and diesel costs, CPIX inflation
measured 3,6 per cent in both July and August having averaged 3,4 per cent for the previous
12 months. This indicates that thus far there has been limited pass-through from petrol prices to prices
of other goods and services.
Other categories of goods and services that have shown significant price increases are tobacco
products, domestic workers' wages, medical costs and education. In contrast, prices of clothing and
footwear have continued to fall, while most other categories show very subdued price increases.
Despite recent increases in the maize price, food price inflation has remained low, measuring
2,7 per cent in August. Administered prices excluding petrol rose at 5,9 per cent, marginally below the
upper limit of the inflation target range. However if the petrol price is included, administered prices
increased by 11,2 per cent.
Production price inflation has also displayed a marked upward trend, reflecting to a significant degree
the higher energy prices. Having measured 2,4 per cent in May 2005, production price inflation
increased steadily, reaching 4,2 per cent in August. Imported goods inflation increased from an annual
rate of 1,8 per cent in May to 6,2 per cent in August, while domestically produced goods inflation
increased from 2,6 per cent to 3,6 per cent over the same period.
The outlook for inflation
Owing mainly to the adverse oil price developments, the Bank's inflation forecast has deteriorated
somewhat since the last MPC meeting. However CPIX inflation is expected to remain within the target
range of 3-6 per cent over the forecast period. The upper turning point is expected to occur in the first
two quarters of 2006 at a level just below 6 per cent. Thereafter, CPIX inflation is expected to resume
a moderate downward trajectory. Although there are no clear signs of second-round effects, the longer
the upward trend and volatility of oil prices persist, the more likely the price increases will continue to
impact on expectations and feed through to other prices. Monetary policy has to remain vigilant in
anticipating such developments.
Since the last meeting of the MPC, the international crude oil prices reached new record levels of
almost US$70 per barrel in the wake of the hurricanes in the United States. The price of Brent crude
averaged around US$64.50 per barrel in August and US$63 in September, compared to US$58 in
July. These developments resulted in further increases in the domestic petrol price of R0,29 and
R0,12 per litre in September and October respectively, and will contribute to further upward pressure
on CPIX in those months. More recently crude oil prices have declined to below US$60 per barrel and
if this trend continues, we could see a moderate decline in petrol prices in November. However the
volatility of international oil prices means that significant upside risk remains.
There are a number of other developments that also pose risks to the inflation outlook. The latest
inflation expectations survey conducted by the Bureau for Economic Research at the University of
Stellenbosch indicates that there has been a marginal deterioration in inflation expectations which may
be a result of the impact of the higher petrol prices. CPIX inflation is now expected to average 5,2 per
cent next year, and 5,4 per cent in 2007, up 0,3 per cent and 0,4 per cent respectively. The
deterioration in inflation expectations was also reflected in the increase in the breakeven inflation
rates, measured by the spreads between the yields on South African CPI inflation-linked bonds and
conventional nominal bonds of the same maturity. If the deterioration in inflation expectations were to
continue, it would be a cause for concern given the critical role of expectations in the price and wage
formation process.
The economy has continued to grow at a robust pace, with quarter-on-quarter annualised real GDP
growth accelerating from 3,5 per cent in the first quarter of 2005 to 4,8 per cent in the second quarter.
This acceleration was attributed in part to the strong increase in the real value added by the
manufacturing sector, which appears to have recovered from the contraction in the first quarter. The
utilisation of production capacity in manufacturing, having fallen back in the previous two quarters,
picked up again in the second quarter of 2005. The physical volume of manufacturing production
continued on an upward trend in the third quarter and the most recent value of the Investec/BER
Purchasing Manager's Index (PMI) also indicates that the recovery in this sector has continued,
although at a more moderate pace. Most other sectors have also remained buoyant and the
composite leading business cycle indicator shows a favourable growth outlook.
This positive growth performance had a positive effect on employment. According to the Quarterly
Employment Statistics survey, formal non-agricultural employment increased at an annualised
quarteron-quarter rate of 7,6 per cent in the second quarter of this year. Over the past year this reflects an
increase of 84,000 employees.
Domestic demand shows few signs of significant moderation and all components of final demand grew
at a healthy rate in the second quarter. New motor vehicle sales reached new record highs in
September, although there was a moderate slowdown in the growth of motor vehicle sales which
increased by 25,3 per cent over the year. The strong domestic demand has been underpinned by low
nominal interest rates, higher real incomes and increases in asset prices. Share prices on the JSE
Limited, for example, reached new record highs, and since the previous MPC meeting the all-share
price index increased by 4 per cent.
The vigorous demand was financed in part by increased borrowing, and the household debt ratio
continued to rise in the second quarter. Household debt as a percentage of disposable income rose
from 60 per cent in the first quarter to 62 per cent in the second quarter of 2005. However, because of
the low nominal interest rate environment, debt servicing cost as a percentage of disposable income
remained unchanged at a relatively low level of 61⁄2 per cent.
The monetary and credit aggregates have also been increasing at rates consistent with strong
domestic demand. Year-on-year growth in M3 picked up from 17,1 per cent in June 2005 to 19,9 per
cent in July and 19,0 per cent in August. Total domestic credit extension grew by 18,0 per cent in July
and 18,3 per cent in August. Twelve-month growth in bank loans and advances to the private sector
remained above 20 per cent, with increases in mortgage advances reaching 26 per cent in August.
The latter reflects continued buoyancy in the housing market, although the rate of increase in house
prices has fallen steadily since September 2004.
Strong domestic demand and high international crude oil prices have impacted on the current account
of the balance of payments. Although the deficit on the current account of the balance of payments as
a percentage of GDP contracted to 3,4 per cent in the second quarter of 2005, data for July and
August indicate a possible widening of the trade deficit in the third quarter. The current account
however remains financed by capital inflows, and the international liquidity position of the Bank
increased to a level of US$16,1 billion at the end of September.
World inflation is expected to be negatively affected by higher oil prices. The IMF now predicts that
world inflation in 2006 will average 3,7 per cent, compared to the April forecast of 3,1 per cent for the
same period. Nevertheless this is lower than the revised 3,9 per cent average expected for 2005 and
indicates that world inflation appears to be well contained. World growth is expected to be sustained at
a robust rate of 4,3 per cent in 2006 although it has moderated somewhat since last year.
Not all developments have been negative from an inflation perspective. Although inflation expectations
have deteriorated moderately, there is no evidence that this has impacted on wage settlements. Unit
labour costs in the first half of this year increased at rates within the inflation target range, measuring
4,6 per cent and 5,3 per cent in the first two quarters of this year.
The nominal effective exchange rate of the rand depreciated by 0,3 per cent since the last meeting of
the MPC, but it has been relatively stable over the period. The volatility that did occur was to a large
extent a reflection of movements between the euro and the US dollar. Positive international
perceptions of South Africa were further confirmed with the recent sovereign credit rating upgrade by
the Fitch rating agency.
Monetary policy stance
The deterioration in the inflation outlook cannot be ignored. The increased risk of possible
pass-through leading to pronounced second-round effects on CPIX inflation must inform policy going
forward. Although there is no conclusive evidence of pass-through at present, and the Monetary Policy
Committee has not judged it necessary to change the monetary policy stance at this meeting, these
developments will be closely monitored. The Committee stands ready to take the appropriate action in
order to ensure that the inflation target mandate continues to be achieved. At this meeting the MPC
has decided therefore that the repurchase rate will remain unchanged at 7 per cent per annum.