Latest forecasts show a marked deterioration in the inflation outlook, particularly in the short term, South African Reserve Bank (SARB) Governor Tito Mboweni cautioned on Thursday.
Speaking after the SARB’s monetary policy committee (MPC) announced it had decided to raise the repo rate by 50 basis points to 7,5%, Mboweni said that whereas a previous forecast had projected CPIX inflation to peak at a level just below 5% in the first quarter of 2007, it is now expected to breach the upper end of the target range and to peak at a level of 6,2% at that time.
CPIX inflation is then expected to fall back below the upper end of the target by the next quarter, and by the third quarter it is projected to decline further to 5,2%. Inflation is then expected to continue to moderate gradually to reach 4,8% by the end of 2008.
“The main reason for the deteriorating outlook is a significant upward revision of the international oil-price assumptions,” Mboweni said.
He said the risks to the previously benign inflation outlook in South Africa have increased over the past few weeks. Uncertainties relating to the future movements of United States interest rates have had reverberations in international financial markets, with negative consequences for a number of emerging markets, in particular. This has put some downward pressure on commodity prices and contributed to a marked depreciation of the rand since the last meeting of the MPC.
“These events have occurred at a time of continued geopolitical tensions which have driven international oil prices to new record highs,” Mboweni said.
Domestically, consumer demand has remained robust, and there are few signs of moderation. Growth in credit extension has continued at a brisk pace and household debt has continued to rise, while the current-account deficit of the balance of payments has widened further.
Domestic output growth in the first quarter of 2006 returned to a level more in line with potential output following the improved performance of the manufacturing sector in the first quarter of 2006.
Favourable factors to the inflation outlook, Mboweni said, include the continued fiscal discipline, the moderate trend in unit labour costs and the benign world inflation. The International Monetary Fund expects world inflation to decline from a projected 3,8% in 2006 to 3,5% next year, despite higher international oil prices.
South Africa’s growth performance improved during the first quarter of 2006 to a rate of 4,2%, compared with the revised 3,2% growth in the fourth quarter of last year. The improved performance occurred despite contractions in both agriculture and mining.
The manufacturing sector made a good recovery and grew by 4,3% following a mild contraction in the final quarter of 2005. The latest Investec/BER purchasing manager’s Index indicated that this improved performance might continue in the second quarter, despite the downturn recorded in April.
“Overall growth in 2006 is expected to remain more or less in line with potential output,” Mboweni said.
However, he added: “Although inflation is expected to remain within the target range for most of the forecast period, the risks are still seen to be on the upside. Household real consumption expenditure increased in the first quarter of 2006, at a rate roughly the same as that in the previous quarter, and in line with the 6,9% increase in 2005. Motor-vehicle sales remain at a high level although on a month-on-month basis a 4,1% decrease was recorded in May of this year.”
These developments continue to be reflected in the growth of credit extension. Twelve-month growth in bank loans and advances extended to the private sector measured 23,1% in April compared with 24,3% in March, while asset-backed credit extended to the private sector continued to grow strongly at a year-on-year rate of 27,2% in April, reflecting strong growth in mortgage advances.
“This has resulted in a further increase in consumer indebtedness. In the first quarter of 2006, the ratio of household debt to GDP [gross domestic product] had risen to approximately 68%, compared to 65,5% the previous quarter. The cost of servicing the debt has remained fairly stable at around 7%.”
The SARB governor added that high levels of expenditure contributed to the continued widening in the deficit on the current account of the balance of payments in the first quarter of 2006. This arose in part as a result of weak export-volume growth and higher volumes and values of crude oil imports, particularly in January and February, when significantly large trade deficits were recorded.
“The widening deficit has nevertheless been more than financed by capital inflows. These inflows enabled the [SARB] to further increase its holdings of foreign-exchange reserves. By the end of May, official gross gold and other foreign-exchange reserves had increased to $24,1-billion, while the international liquidity position had increased to $20,4-billion,” Mboweni said.
He said the international environment has also posed increased risks to the inflation outlook. Since the last meeting of the MPC, the exchange rate of the rand has come under pressure as a result of developments in international financial and commodity markets. Previously the relative exchange-rate stability had contributed to the positive inflation outlook.
The continued uncertainties on the international financial and commodities markets have also added to inflation risk. — I-Net Bridge