in september from an april low. manufacturing production, which had stagnated for the past five years, increased in both july and august to its highest levels in more than a year. the rebound in the mining sector has been even more pronounced. it would therefore appear that both sectors will contribute positively to gdp growth in the third quarter of page 7 of 11 this year. the rmb / ber9 business confidence index, while still well below the neutral 50 mark, rose off eight - year lows in the previous quarter. however, all this is no cause for premature celebration. many factors still limit the room for a meaningful improvement in south african economic growth. confidence remains highly vulnerable to upcoming political events given their potential implications for important government policies ; it also remains vulnerable to the risk of further sovereign credit rating downgrades. a further rise in the oil price could boost inflation and undermine the terms of trade. and the extent of the impact that the normalization of monetary policies in the advanced economies could have on emerging - market assets, including the rand and domestic securities, is still unclear. even in a relatively favourable scenario – where confidence gradually improves, inflation remains moderate, and the output gap gradually closes – structural factors are likely to limit the scope for a meaningful growth pickup. productivity performance remains weak, with an average annual gain of only 1. 2 % in the past five years. the shortages of skilled labour are likely to remain acute for an extended period of time even if educational outcomes improve. job - searching costs are high, making it that much more difficult for low - skilled people to find employment. and the relatively high concentration in many sectors, together with elevated regulation, results in barriers to entry for new firms. 10 consequently, even with the gradual removal of infrastructure bottlenecks – for example, as more power supply comes on stream – it is difficult to envisage much of a pickup in potential growth in the next two years or so. for these reasons, the sarb projects only a moderate acceleration in actual real gdp growth, from 0. 6 % this year to 1. 2 % in 2018 and 1. 5 % in 2019. how can monetary policy help? how should monetary policy respond to such a situation? conventional wisdom may argue that, in the wake of a slowdown, interest rates should be reduced so as to 9 rand merchant bank / bureau for economic research 10 see oecd economic survey : south africa, 2017. page 8 of 11 rekindle domestic

rates in both the third quarter of 2020 and 2021 as a whole. but they can be misleading. in level terms, our model only expects real gdp to gradually converge back towards pre - covid - 19 levels. at the time of the september mpc meeting, the quarterly projection model ( qpm ) pointed to a large output gap that will only gradually narrow over the remainder of the forecasting period and remain negative even in 2022. the combination of ongoing economic slack, an undervalued real effective exchange rate and a recent decline in medium - term inflation expectations suggest that inflation should not be a problem for the next two years or so. the qpm projects that both headline and core inflation rates will remain largely within the lower half of the target until the end of 2022, with the exception of a short - lived spike in the headline inflation rate in the second quarter of next year as a low base distorts energy price inflation. baring materialisation of upside risks, this benign inflation outlook should allow the sarb to maintain an accommodative stance for most of the coming two years, and only withdraw stimulus in a gradual fashion, as the output gap slowly closes. indeed, the latest qpm projections are consistent with a rise in the policy rate to 4. 0 % by the end of 2021 and 5. 0 % in 2021, which would still be 100 basis points below the average of the past decade. 5. can there be a new paradigm in the long run? in summary, there appears to be a growing consensus – both among forecasters and policymakers – that the interest rate cycle in the next couple of years, both globally and in south africa, is going to be one of gradual normalisation. but towards which levels are interest rates going to normalise, and what is going to be their average over the longer term – say, a horizon of five years or longer? few economists presently seem willing to make forecasts over such a horizon, at a time when it is not yet clear how long the pandemic will be with us. will the past few decades ’ trends towards lower equilibrium interest rates persist or, on the contrary, will covid - 19 usher in structural changes that are consistent with higher interest rates over time? economic theory tells us that equilibrium interest rates should reflect potential real gdp growth, inflation expectations and a risk premium that varies with the term of the loan and the creditworthiness of the borrower. the outlook for all