South Africa ups repo rate to 5½%; rand weakening; inflation to breach upper end of target

By Marisa Wong

Madison, Wis., Jan. 29 - South African Reserve Bank's Monetary Policy Committee has decided to increase the repurchase rate by 50 basis points to 5½% as of Jan. 30, according to a bank announcement.

The committee said it believes that despite the increase in the repo rate, monetary policy remains accommodative.

The committee also noted that further moves in the repo rate will be highly data dependent and it will continue to monitor developments closely.

Since the previous meeting in November, the expected cutback in quantitative easing by the U.S. Federal Reserve has begun. Although the initial response in global financial markets was generally fairly muted, emerging markets have subsequently experienced a high degree of turbulence, particularly in the wake of renewed fears of a slowdown in China, the committee said.

"While the Fed action signals a recovery in the United States and the U.K. economic outlook is also improving, we are now entering a phase of the crisis that is creating new challenges for emerging market economies," the bank said.

The rand exchange rate has been one of the currencies affected by these developments, and the recent depreciation of the rand, if sustained, will raise the risk to the inflation outlook significantly, the committee said. The bank's inflation forecast shows a marked deterioration, despite the absence of clear evidence of domestic demand pressures.

Since the previous meeting, the rand has depreciated by about 7.4% against the dollar, by 9% against the euro and by 8% on a trade weighted basis. Year to date the rand/dollar depreciation has been about 3.5%, according to the bank release.

In the final two months of 2013, total net sales by non-residents of South African domestic government bonds and equities amounted to ZAR 21 billion and ZAR 19.4 billion, respectively. These flows effectively reversed the inflows that occurred during the earlier part of the year, with net purchases of bond and equities for 2013 by non-residents amounting to ZAR 1.3 billion, compared with ZAR 85.2 billion for 2012. Year-to-date net sales of equities and bonds have totaled ZAR 19.3 billion, of which ZAR 15.6 billion were bonds.

While the recent rand weakness is part of a general emerging market phenomenon, it has been reinforced by idiosyncratic factors, including declining terms of trade, ongoing labor disputes and the higher-than-expected current account deficit in the third quarter, the committee commented.

The committee pointed out that recent inflation data reflects positive outcomes that belie the incipient risks largely from the depreciation of the rand. The year-on-year inflation rate as measured by the consumer price index for all urban areas measured 5.3% in November and 5.4% in December, resulting in an average annual inflation rate of 5.7% for 2013.

Food and non-alcoholic beverage price inflation continued to moderate from a recent peak of 7.2% in August, to 3.8% in November and 3.5% in December. The contribution of this category to the average CPI increase was 0.5 percentage points in December compared with 0.6 percentage points in the previous month.

The petrol price, which was the main contributor to the higher overall inflation in December, increased at a year-over-year rate of 10%, up from 7.7% in November.

Core inflation, which excludes food, petrol and electricity, has been unchanged at 5.3% for the four months to December, while administered price inflation excluding petrol measured 6.8%. The headline producer price inflation for final manufactured goods measured 5.8% in November, compared with 6.3% in October.

Inflation forecast

The bank's headline inflation forecast has deteriorated since the committee's previous meeting, mainly as a result of revisions to assumptions regarding the rand exchange rate. The forecast average inflation rate for 2014 is 0.6 percentage points higher at 6.3% and 0.6 percentage points higher at 6% in 2015, with inflation expected to average 5.9% in the final quarter of that year.

Inflation is expected breach the upper end of the target range in the second quarter of 2014 and to reach a peak of 6.6% in the final quarter of 2014, before declining to 6% in the second quarter of 2015.

Core inflation, which averaged 5.2% in 2013, is expected to average 5.8% in 2014, compared with 5.6% in the previous forecast, while the forecast for 2015 has increased to 5.9% from 5.3%.

Overall, inflation expectations appear to have remained relatively anchored at the upper end of the target range, the committee said.

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