the foreign exchange and in the money markets, but mainly with the intention of supporting an orderly adjustment in market prices. it - 3was never the intention to try and fix the exchange rate of the rand at any predetermined artificial level, neither did the bank try to keep interest rates unrealistically low. it was furthermore accepted that, after the relatively large depreciation in the exchange rate and taking account also of the “ openness ” of the south african economy, the rate of inflation would rise. the challenge for monetary policy was, however, to constrain the rate of increase in inflation to a first round effect only, and to prevent prices from going into an uncontrollable and perpetuating inflationary spiral. in retrospect, the policy seemed to have worked quite well. the restrictive monetary policy, and particularly the rise in interest rates, were not received with unanimous support by all sectors of the south african community. interest rates, however, remain one of the main disciplines of the market economy and countries that are not prepared to bear the effects of this discipline from time to time will be punished by the markets. this basic lesson is now being learned again by a number of countries in the east asia region where interest rates recently soared to a much higher level than ever experienced by south africa. now that the overall macroeconomic consolidation process has made good progress, there are some impatient pressures building up on the reserve bank to relax monetary policy quickly and decisively. some of these pressures are still based on the now defunct phillips curve or an assumed trade - off between inflation and growth - - an argument that was buried in most countries of the world already in the 1980s when macroeconomic policy switched the emphasis from a demand - management approach to a supply - side solution. the rapid expansion of communications and the increase in electronically driven capacity for economic analyses further contributed to the more effective implementation of pre - empting expectations, and reduced the opportunity for central bankers to stimulate economies in the short term by applying over - expansionary monetary policies. the south african reserve bank now follows the lead of many other central banks in the world to base monetary policy decisions on developments in financial or monetary aggregates, and not on changes in real economic activity. indeed, the latest fashion is for central banks, together with governments, to target inflation more directly. taking account of typical time - lags that exist between the implementation of monetary policies and their eventual effect on prices, monetary policy adjustments are

x p guma : low domestic inflation in an environment of high oil prices, vigorous household spending and credit demand and a widening current account deficit ; and the outlook for interest rates in south africa luncheon address by dr x p guma, deputy governor of the south african reserve bank, at investec, pretoria, 4 july 2006. * * * inflation in the world economy has declined significantly in recent years and has remained relatively subdued over the past few years despite a significant rise in commodity prices and strong economic growth. chart 1, based on world bank data illustrates the trend in world inflation, clearly showing the peak that occurred at a rate in excess of 35 percent per annum in the early 1990s and the rapid deceleration to rates around 5 per cent per annum thereafter. south africa ’ s inflation performance began to improve during the 1990s, as the next chart indicates ; and subsequent to the adoption of the inflation targeting framework, inflation as measured by cpix entered and has remained within the target range since september 2003. oil prices have risen sharply since 2003 ( as the next chart indicates ), on account of various determinants. during this year, the spot price of brent crude oil has increased dramatically from approximately us $ 59. 9 per barrel in february to levels around us $ 70. 5 per barrel towards the end of april and an average of us $ 68. 15 per barrel in june. continued brisk expansion in final consumption expenditure by households has been underpinned by a steady increase in household disposable income, continued buoyancy in the real estate and securities markets and what some describe as an accommodative interest rate environment. overall household debt as a percentage of annualised disposable income increased to a record level of 68 percent in the first quarter of 2006. robust growth in gross domestic expenditure and a concomitant strong increase in the value of merchandise imports resulted in a sizeable deficit on the trade account of the balance of payments in the first quarter of 2006. given the larger shortfall on the services and income account with the rest of the world and the somewhat subdued performance of south africa ’ s exports – notwithstanding the buoyancy of international commodity prices, the current account of the balance of payments registered a deficit equivalent to 6. 4 percent in the first quarter of 2006. interestingly, as others have observed, despite the sell - off in emerging markets since may, nonresidents have remained net buyers of south african financial assets and there have